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Bargained Haircuts and Debt Policy Implications

Aloisio Araujo, Marcia Leon and Rafael Santos ()

No 416, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: We extend the Cole and Kehoe model 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

Date: 2016-01
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