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Default Costs, Willingness to Pay and Sovereign Debt Buybacks

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  • Jonathan P. Thomas

    (University of St Andrews)

Abstract

The arguments put forward by Bulow and Rogoff (1988, 1991) against sovereign debt buybacks are re-examined in a willingness-to-pay framework. This paper argues that the Bulow-Rogoff framework treats default by a debtor as an event with no dead-weight loss, and, as such, underestimates the potential gains from a buyback. The willingness-to- pay framework allows dead-weight costs of default to be introduced in a consistent and simple fashion into the buybacks calculus. Two versions of this framework are considered. First, a model in which the default costs induce an all-or-nothing default decision is analysed. In this case, an ambiguous result is derived in which the variability of the debtor’s income determines whether (small) buybacks are beneficial to the debtor, even though expected total transfers to the creditor increase, consistent with Bulow-Rogoff. In a second version, default costs are modelled so as to induce at most a partial default. This model corresponds most closely, in terms of the repayment behaviour of the sovereign debtor, to the models used by Bulow and Rogoff. It is shown that small buybacks are always beneficial to the debtor in this case. The second version is extended to include an investment opportunity. Only if the country has sufficiently scarce resources when the investment can be made, will a buyback be harmful to the interests of the debtor.

Suggested Citation

  • Jonathan P. Thomas, 2001. "Default Costs, Willingness to Pay and Sovereign Debt Buybacks," International Finance 0103002, University Library of Munich, Germany.
  • Handle: RePEc:wpa:wuwpif:0103002
    Note: Type of Document - PDF; prepared on IBM-PC; pages: 22 ; figures: none. 22 pages, PDF
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    References listed on IDEAS

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    Cited by:

    1. Mr. Carlos I. Medeiros & Parmeshwar Ramlogan & Ms. Magdalena Polan, 2007. "A Primer on Sovereign Debt Buybacks and Swaps," IMF Working Papers 2007/058, International Monetary Fund.

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    More about this item

    Keywords

    Sovereign Debt Buybacks Sanctions Willingness to Pay;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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