Debt Dilution and Sovereign Default Risk

Juan Hatchondo, Leonardo Martinez and Cesar Sosa-Padilla

Journal of Political Economy, 2016, vol. 124, issue 5, 1383 - 1422

Abstract: We measure the effects of debt dilution on sovereign default risk and study debt covenants that could mitigate these effects. We calibrate a baseline model with endogenous debt duration and default risk (in which debt can be diluted) using data from Spain. We find that debt dilution accounts for 78 percent of the default risk in the baseline economy and that eliminating dilution increases the optimal duration of sovereign debt by almost 2 years. Eliminating dilution also increases consumption volatility but still produces welfare gains. The debt covenants we study could help enforcing fiscal rules.

Date: 2016
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Related works:
Working Paper: Debt Dilution and Sovereign Default Risk (2015)
Working Paper: Debt Dilution and Sovereign Default Risk (2014)
Working Paper: Debt dilution and sovereign default risk (2012)
Working Paper: Debt dilution and sovereign default risk (2012)
Working Paper: Debt Dilution and Sovereign Default Risk (2011)
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