Delay and Haircuts in Sovereign Debt - University of St Andrews

is altered ex ante relative to their interim Pareto ranking conditional on
default.
Nevertheless, in some situations, namely those where debtor payo¤s are
lower in the case of one-period delay relative to two-period delay, the information
role of the IMF could improve ex ante e¢ ciency. A potentially
serious challenge to carrying out this informational role is that the IMF faces
a con‡ict of interest: as a senior creditor, it presumably has an incentive to
exaggerate sustainability requirements in favour of the debtor to minimize
other claims on the debtor’s resources. Would such induced compassion
for the debtors not be checked by its creditor-dominated Executive Board?
If not, this informational task could be delegated elsewhere, perhaps to the
Inter-American Development Bank for cases of Latin American debt restructuring,
for example. Moreover, conditional on default, the debtor may have
an incentive to manipulate the information available to, and subsequently
made public by, the IMF.
6 Conclusion
One of the striking aspects of the recent sovereign debt restructurings is
that, conditional on default, long delay is positively correlated with size of
haircut. In this paper, abstracting away from the issues of creditor coordination,
we develop a bargaining model to account for this, highlighting
the economic recovery and sustainability considerations as complementary
reasons for delay.
With stochastic bargaining surplus and asymmetric information about
the debtor’s sustainability concern, we show that multi-period costly delay
arises in a Perfect Bayesian equilibrium, initially re‡ecting economic recovery
followed by signalling about sustainability. A key result of the model
shows that prolonged delay is positively correlated with a large haircut.
This result is supported by empirical evidence. We, then, examine the ex
ante incentives of the sovereign debtor and …nd that the Pareto ranking of
equilibria, conditional on default, can be altered once ex ante incentives are
taken into account. Finally, we use our results for examining a number of
policy proposals put forward to ensure an orderly restructuring of sovereign
debts. We argue that the IMF could help by providing information on future
growth prospect of the debtor country as well as publishing its best
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