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Bargained haircuts and debt policy implications

Aloisio Araujo, Marcia Leon () and Rafael Santos ()
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Marcia Leon: Research Department, Banco Central do Brasil

Economic Theory, 2017, vol. 64, issue 4, No 3, 635-656

Abstract: Abstract We extend the Cole and Kehoe model (J Int Econ 41:309–330, 1996) by adding a Rubinstein bargaining game between creditors and debtor country to determine the share of debt repayment in a sovereign debt crisis. Ex-post, the possibility of partial repayment avoids the costly case of total default, as seen recently in Greece. Ex-ante, the effects are to increase the sovereign debt cap and delay the fiscal adjustment. In other words, expectations of a haircut in times of crisis relax leverage restrictions implied by financial markets and make government more lenient, suggesting caution with haircut adoption, especially when risk-free interest rates are low.

Keywords: Partial default; Speculative attacks; Debt crisis; Leverage (search for similar items in EconPapers)
JEL-codes: F34 G01 H63 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1007/s00199-016-0981-4

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