Making Sovereign Debt Safe with a Financial Stability Fund

Adrien Wicht, Yan Liu and Ramon Marimon

No 1331, Working Papers from Barcelona School of Economics

Abstract: We develop an optimal design of a Financial Stability Fund that coexists with the international debt market. The sovereign can borrow long-term defaultable bonds on the private international market, while having with the Fund a long-term contingent contracts subject to limited enforcement constraints. There is a contract that minimizes the debt absorbed by the Fund, guaranteeing full debt stabilization. In equilibrium, the seniority of the Fund contract, with respect to the privately held debt, is irrelevant. We calibrate our model to the Italian economy and show it would have been a more efficient path of debt accumulation with the Fund.

Keywords: Debt Overhang; safe assets; recursive contracts; limited enforcement; debt stabilisation; seniority structure (search for similar items in EconPapers)
JEL-codes: E43 E44 E47 E62 F34 F36 F37 (search for similar items in EconPapers)
Date: 2022-03
New Economics Papers: this item is included in nep-dge
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Citations: View citations in EconPapers (2)

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Working Paper: Making sovereign debt safe with a financial stability fund (2022)
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