Delay and Haircuts in Sovereign Debt - University of St Andrews

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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 24
estimates on the sovereign debtor’s debt sustainability. Combining the reasons for delay examined in this paper with those driven by creditor coordination and creditor moral hazard remains a topic for future research. Acknowledgement The authors are grateful to the ESRC under Projects RES 156-25-0032 and RES 051-27-0125. We thank Javier García-Fronti, Daniel Heymann and participants at RES Conference 2010 and seminars in the Bank of Spain and the University of San Andres for helpful comments. References [1] Y. Bai, J. Zhang, Duration of Sovereign Debt Renegotiation, 2009. [2] D. Benjamin, M.L.J. Wright, Recovery Before Redemption: A Theory of Delays in Sovereign Debt Renegotiations. CAMA Working Paper 15/2009, Centre for Applied Macroeconomic Analysis, The Australian National University. [3] S. Bhattacharya, E. Detragiache, The role of international institutions in the market for sovereign debt, Scandinavian Journal of Economics. 96 (1994), issue 4, 515-529. [4] R. Bi, Bene…cial Delays in Debt Restructuring Negotiations, IMF Working Paper 08:38, 2008. [5] P. Blustein, And the Money Kept Rolling In (and Out), Public A¤airs, New York, 2005. [6] E.R. Borensztein, P. Mauro, Reviving the Case for GDP-Indexed Bonds, IMF Policy Discussion Paper 02:10, 2002. [7] E.G. Bruno, El Default y la Reestructuración de la Deuda, Nueva Mayoría, Buenos Aires, 2004. [8] J. Bulow, K. Rogo¤, A Constant Recontracting Model of Sovereign Debt, Journal of Political Economy. 97 (1989), issue 1, 155-178. [9] R.J. Caballero, On the International Financial Architecture: Insuring Emerging Markets, Journal of Financial Transformation. 7(2003), 8-12. 25
Page 1 and 2: Delay and Haircuts in Sovereign Deb
Page 3 and 4: Source: Table 14 and 15 in Sturzene
Page 5 and 6: debtor and the creditor. Dhillon et
Page 7 and 8: The Optimistic and the Cautious deb
Page 9 and 10: Delay occurs at t = 1 if the debtor
Page 11 and 12: Table 5: Continuation values for th
Page 13 and 14: elow the expected payo¤ for the cr
Page 15 and 16: Thus, conditional on default, relat
Page 17 and 18: Length of Default (Delay) and Haric
Page 19 and 20: 2004 together with a decline in the
Page 21 and 22: The …rst-order condition characte
Page 23: creditor coordination but focusing
Page 27 and 28: [22] A. Merlo, C. Wilson, A Stochas
Page 29 and 30: creditor is the proposer, his o¤er
Page 31 and 32: while the debtor’s expected payo
Page 33: After a simpli…cation, we obtain:

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