Why do Sovereign Borrowers Post Collateral? Evidence from the 19th Century

Marc Flandreau (), Stefano Pietrosanti and Carlotta Schuster
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Marc Flandreau: University of Pennsylvania
Stefano Pietrosanti: Bank of Italy
Carlotta Schuster: UNCTAD

No inetwp167, Working Papers Series from Institute for New Economic Thinking

Abstract: This paper explores the reasons why sovereign borrowers post collateral. Such behavior is paradoxical because conventional interpretations of collateral stress repossession of the assets pledged as the key to securing lenders against information asymmetries and moral hazard. However, repossession is generally difficult in the case of sovereign debt and in some cases impossible. Nevertheless, such sovereign `hypothecations` have a long history and are again becoming very popular today in developing countries. To explain sovereign collateralization, we emphasize an informational channel. Posting collateral produces information on opaque borrowers by displaying borrowers` behavior and resources. We support this interpretation by examining the hypothecation `mania` of 1849-1875, when sovereigns borrowing in the London Stock Exchange pledged all kinds of intangible revenues. Yet, at that time, sovereign immunity fully protected both sovereigns and their assets and possessions. Still, we show that hypothecations significantly decreased the cost of sovereign debt. To explain how, we stress the pledges` role in documenting sovereigns` wealth and the management of revenue streams. Based on an exhaustive library of bond prospectuses collected from primary sources, matched with a panel of sovereign bond yields and an innovative measure of sovereign fiscal transparency, we show that collateral minutely described in debt covenants served to document and monitor sovereign resources and development prospects. Encasing this information in contracts written by lawyers served to certify the quality of the resulting data disclosure process, explaining investors` readiness to pay a premium.

Keywords: Collateral; Information; Sovereign debt; Informal enforcement; Financial innovation; Contract innovation (search for similar items in EconPapers)
JEL-codes: G24 H63 K12 K33 N20 (search for similar items in EconPapers)
Pages: 71 pages
Date: 2021-10-07
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-fdg, nep-his and nep-law
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Persistent link: https://EconPapers.repec.org/RePEc:thk:wpaper:inetwp167

DOI: 10.36687/inetwp167

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