Sovereign CoCos and debt forgiveness

Juan Carlos Hatchondo, Leonardo Martinez, Yasin Kürşat Önder and Francisco Roch

Journal of Monetary Economics, 2025, vol. 153, issue C

Abstract: We study a sovereign default model in which the government issues CoCos (contingent convertible bonds) that stipulate a suspension of debt payments upon a sizable increase of the global risk premium (and thus, of the government’s borrowing cost). We find that CoCos allow the government to smooth out the effects of risk-premium shocks on consumption, but they increase the default frequency. By suspending debt payments, CoCos imply higher debt levels and, thus, higher default probabilities after adverse shocks. We also study CoCos that, in addition to the payment suspension, stipulate debt forgiveness after adverse shocks. In contrast with no-forgiveness CoCos, debt-forgiveness CoCos reduce debt levels after adverse shocks, thereby reducing default probabilities. Debt-forgiveness CoCos also yield larger welfare gains.

Keywords: Sovereign default; CoCos; Debt relief; Reprofiling; Debt forgiveness (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:153:y:2025:i:c:s0304393225000558

DOI: 10.1016/j.jmoneco.2025.103784

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