 State-contingent debt with lender risk aversionThe Quarterly Review of Economics and Finance, 2024, vol. 94, issue C, 180-189 Abstract: State-contingent debt has the potential to eliminate costly debt crises. Yet, markets for this type of debt remain essentially closed. This paper uses a simple model to show conditions under which specialized risk-averse foreign lenders prefer non-contingent debt to state-contingent debt. Borrowers always prefer state-contingent debt as non-contingent debt increases the probability of default and reduces investment and output. However, lenders face a trade-off between the total surplus generated by the investment project and the share that they appropriate through the financial trade. Even though total surplus is smaller with non-contingent debt when compared to state-contingent debt, the share of the surplus that goes to lenders is larger under non-contingent debt. The paper then characterizes environments where state-contingent debt is more likely to be preferred by both borrowers and lenders under risk aversion. Keywords: State-contingent debt; Financial innovation; Risk aversion; Sovereign default (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:94:y:2024:i:c:p:180-189 DOI: 10.1016/j.qref.2024.01.009 Access Statistics for this article The Quarterly Review of Economics and Finance is currently edited by R. J. Arnould and J. E. Finnerty More articles in The Quarterly Review of Economics and Finance from Elsevier |
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