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Duration of Sovereign Debt Renegotiation

Yan Bai () and Jing Zhang ()

No 593, Working Papers from Research Seminar in International Economics, University of Michigan

Abstract: The structure of sovereign debt has evolved over time from illiquid bank loans toward liquid bonds that are traded on the secondary market in the past two decades. This change in the debt structure is accompanied with a reduction in the duration of sovereign debt renegotiation; it takes on average 9 years to restructure bank loans, but only 1 year to restructure bonds. In this work, we argue that the secondary market plays an important role -- information revelation -- in reducing the renegotiation length. We construct a dynamic bargaining game between the government and the creditors with private information on the creditors' reservation value. The government uses costly delays as a screening device for the creditors' type, and so the delays arise in equilibrium. Moreover, the more severe is the private information, the longer the delays are. When we introduce the secondary market, the equilibrium delays are greatly reduced. This is because the secondary market price conveys information about the creditors' reservation and lessens the information friction. We also find that bond financing is more friendly to the debtor country; it increases ex-ante borrowing and investment and ex-post renegotiation welfare of the government.

Keywords: sovereign debt renegotiation; secondary bond markets; dynamic bargaining; incomplete information (search for similar items in EconPapers)
JEL-codes: F02 F34 F51 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2009-03
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Journal Article: Duration of sovereign debt renegotiation (2012) Downloads
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