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Trade Credit, International Reserves and Sovereign Debt

  • Kohlscheen, E.

    (Department of Economics, University of Warwick)

  • O’Connell, S. A.

    (Department of Economics, Swarthmore College)

We present a unified model of sovereign debt, trade credit and international reserves. Our model shows that access to short-term trade credit and gross international reserves critically affect the outcome of sovereign debt renegotiations. Whereas competitive banks do optimally lend for the accumulation of borrowed reserves that strengthen the bargaining position of borrowers, they also have incentives to restrict the supply of short-term trade credit during renegotiations. We first show that they effectively do so and then derive propositions that : I) establish the size of sovereign debt haircuts as a function of economic fundamentals and preferences ; II) predict that defaults occur during recessions rather than booms, contrary to reputation based models ; III) provide a rationale for holding costly borrowed reserves and, IV) show that the stock of borrowed international reserves tends to increase when global interest rates are low.

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Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 833.

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Length: 50 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:wrk:warwec:833
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