Sovereign debt as a contingent claim: a quantitative approach

We construct a dynamic equilibrium model with contingent service and adverse selection to quantitatively study sovereign debt. In the model, benefits of defaulting are tempered by higher future interest rates. For a wide set of parameters, the only equilibrium is one in which the sovereign defaults in all states; additional output losses, however, sustain equilibria that resemble the data. We show that due to the adverse selection problem, some countries choose to delay default to reduce loss of reputation. Moreover, although equilibria with no default imply greater welfare levels, they are not sustainable in highly indebted and volatile countries.     

News and sovereign default risk in small open economies

This paper builds a unified model of sovereign debt, default risk, and news shocks. News shocks improve the quantitative performance of the sovereign default model in a number of empirically-relevant dimensions. First, with news shocks, not all defaults occur during downturns. Second, the news shocks help account for key differences between developing and more developed economies: as the precision of news improves, the model predicts lower variability of consumption, less countercyclical trade balance and interest rate spreads, as well as a higher level of debt in line with more developed economies. Third, the model captures the hump-shaped relationship between default rates and the precision of news obtained from the data. Finally, the news shocks have a nonmonotonic effect on welfare.     

欧洲主权债务危机及其影响

2010年2月初以来,随着美国次贷危机对各国经济的影响逐步消退、世界经济复苏越来越明显,欧洲主权债务危机开始进入人们的视野,国际金融市场出现震荡。欧洲主权债务危机对我国的影响主要是间接性的汇率风险,即我国巨额外汇储备中欧元部分的趋势性贬值风险。但是,我国应未雨绸缪,提早做好准备,主动积极应对欧洲主权债务危机。     

中国超额外汇储备的社会成本

依据持有1美元储备资产的社会成本等于私人部门从国外借入短期债务的成本和中央银行从其流动性资产中所获得的收益之间的差额的方法,采用EMBI利差数据计算了中国持有超额外汇储备的社会成本,约为GDP的1.5%。本文认为增加流动性的最优战略是增加储备与减少短期外债并用。     

Defaultable debt, interest rates and the current account

World capital markets have experienced large scale sovereign defaults on a number of occasions. In this paper we develop a quantitative model of debt and default in a small open economy. We use this model to match four empirical regularities regarding emerging markets: defaults occur in equilibrium, interest rates are countercyclical, net exports are countercyclical, and interest rates and the current account are positively correlated. We highlight the role of the stochastic trend in emerging markets, in an otherwise standard model with endogenous default, to match these facts.     

Aggregate scale economies, market integration, and optimal welfare state policy

Using a two-sector-two-country model with aggregate scale economies and unionisation, we show that optimal welfare state policy entails positive levels of unemployment benefits under free-trade and capital mobility. In this setting, economic integration does not reduce the revenue raising capacity of governments and thus does not lead to a race-to-the-bottom in social standards. Instead, trade and capital flows interact with welfare state policies in increasing welfare even when each government acts independently (non-cooperatively) in determining its optimal welfare payment. Cooperation is shown to improve upon non-cooperative outcomes by raising both the generosity of the welfare state and aggregate welfare.     

A more effective euro area monetary policy than OMTs — gold-backed sovereign debt

Given the shortcomings of the current responses to the sovereign debt crisis in the eurozone, the author proposes utilising national gold reserves as collateral for government debt. Gold backing would be quite attractive to bond investors and would significantly ease the burden of high sovereign debt yields, particularly in Portugal and Italy. Moreover, it would achieve this without adding further risky assets to the European Central Bank’s balance sheet and thereby transferring credit risk to Northern European countries.     

Renegotiation, collective action clauses and sovereign debt markets

Collective action clauses (CACs) are provisions specifying that a supermajority of bondholders can change the terms of a bond. We study how CACs determine governments' fiscal incentives, sovereign bond prices, and default probabilities in environments with and without contingent debt and IMF presence. We claim that CACs are likely to be an irrelevant dimension of debt contracts in current sovereign debt markets because of the variety of instruments utilized by sovereigns and the implicit IMF guarantee. Nonetheless, under a new international bankruptcy regime like that recently proposed by the IMF, CACs can increase significantly the cost of borrowing for sovereigns, contrary to what is suggested in previous empirical literature.     

Basic analytics of multilateral lending and surveillance

I analyse the role of multilateral financial institutions in a world of global capital markets assuming that they have an informational advantage over private lenders in the market for sovereign debt. I show that the adverse selection problem in this market may be solved through certification if the multilateral agency does not care too much about borrower country welfare. However, with lending the private information of the agency will be revealed whatever its weighting of borrower welfare vs. private lenders' profits. Multilateral lending on concessional terms also alleviates the moral hazard problem — that investment in creditworthy borrowers is reduced as private lenders seek to avoid ex post default by constraining credit.     

Gunboats, reputation, and sovereign repayment: lessons from the Southern Confederacy

Many states that formed the Southern Confederacy defaulted on sovereign debt sold in international capital markets during the 1840s. The Confederacy also elected President Jefferson Davis, who openly advocated the repudiation of U.S. states' debts while a member of Congress. Despite its poor credit record, the Confederate government managed to float cotton bonds in England that constituted under 2% of its expenditures. The bonds were largely issued to settle overdue debts with gun contractors who had cut off trade credit. The South serviced the bonds as late as March 1865, a time of domestic hyperinflation and weeks before the fall of Richmond. Although the Confederate experience shows that trade sanctions can promote debt repayment, the gunboat model can only account for a small amount of lending. A reputation or another type of sanction would be necessary to support higher levels of lending in international capital markets.     

The stock of external sovereign debt: Can we take the data at ‘face value’?

The stock of sovereign debt is typically measured at face value. Defined as the undiscounted sum of future principal repayments, face values are misleading when debts are issued with different contractual forms or maturities. In this paper, we construct alternative measures of the stock of external sovereign debt for 100 developing countries from 1979 through 2006 that correct for differences in contractual form and maturity. We show that our alternative measures: (1) paint a very different quantitative, and in some cases also qualitative, picture of the stock of developing country external sovereign debt; (2) often invert rankings of indebtedness across countries, which historically defined eligibility for debt forgiveness; (3) indicate that the empirical performance of the benchmark quantitative model of sovereign debt deteriorates by roughly 50% once model-consistent measures of debt are used; (4) show how the spread of aggregation clauses in debt contracts that award creditors voting power in proportion to the contractual face value may introduce inefficiencies into the process of restructuring sovereign debts; and (5) illustrate how countries have manipulated their debt issuance to meet fiscal targets written in terms of face values.     

Sovereign bond spreads determinants in Latin American countries: Before and during the XXI financial crisis

This paper aims to identify the main determinants of sovereign bond spreads in seven Latin American countries and verify the existence of contagion effect over these markets during the last financial crisis. We apply a panel data framework and find that the inflation, terms of trade ratio and the external debt and international reserves (both as percentage of GDP) are key drivers of sovereign bond spreads. Moreover, we test the crisis impact over emerging economies. Our results show that the crisis has a statistically significant impact on the EMBIG spreads since 2008.     

Sovereign Debt Restructuring: The Judge,the Vultures and Creditor Rights

What role did the US courts play in the Argentine debt swap of 2005? What implications does this have for the future of creditor rights in sovereign bond markets? The Judge in the Argentine case has, it appears, deftly exploited creditor heterogeneity – between ‘holdouts’ seeking capital gains and institutional investors wanting a settlement – to promote a swap with a supermajority of creditors. Our analysis of Argentine debt litigation reveals a ‘Judge‐mediated’ sovereign debt restructuring which resolves key issues of Transition and Aggregation – two of the tasks envisaged for the IMF's stillborn Sovereign Debt Restructuring Mechanism. For the future, we discuss how Judge‐mediated sovereign debt restructuring (together with creditor committees) could complement Collective Action Clauses in sovereign bond contracts.     

Sovereign debt crises and credit to the private sector

We use micro-level data to analyze emerging markets' private sector access to international debt markets during sovereign debt crises. We find that these crises are systematically accompanied by a decline in foreign credit to domestic private firms, both during debt renegotiations and for over two years after restructuring agreements are reached. This decline is large, statistically significant, and robust. We find that this effect is concentrated in the non-financial sector and is different for firms in the exporting and in the non-exporting sectors. We also find that the magnitude of the effect depends on the type of debt restructuring agreement.     

Sovereign default and debt renegotiation

This paper develops a small open economy model to study sovereign default and debt renegotiation for emerging economies. The model features both endogenous default and endogenous debt recovery rates. Sovereign bonds are priced to compensate creditors for the risk of default and the risk of debt restructuring. The model captures the interaction between sovereign default and ex post debt renegotiation. We find that both debt recovery rates and sovereign bond prices decrease with the level of debt. In a quantitative analysis, the model accounts for the debt reduction, volatile and countercyclical bond spreads, countercyclical trade balance, and other empirical regularities of the Argentine economy. The model also replicates the dynamics of bond spreads during the debt crisis in Argentina.     

On the Risk of a Sovereign Debt Crisis in Italy

The intention for the Italian government to stimulate business activity via large increases in government spending is not in line with the stabilisation of the public debt ratio. Instead, if such policy were implemented, the risk of a sovereign debt crisis would be high. In this article, we analyse the capacity of the Italian economy to shoulder sovereign debt under different scenarios. We conclude that focusing on growth enhancing structural reforms, would allow for moderate increases in public expenditure.     

The arrival of the Euro and its implications for Asia

The third stage of the European Economic and Monetary Union (EMU) commenced on January 1, 1999 with the launch of the European single currency, the euro. The first round of participants comprises 11 of the 15 European Union (EU) nations, dubbed “Euroland.” The potential implications of EMU for Asia are immense. The euro's emergence as an international currency and its impact on Asia can be assessed in 3 different domains: (1) as a medium of exchange for Europe's trade with Asia; (2) as a store of value in stocks and bonds in world capital markets; and (3) as part of official foreign exchange reserves of Asian central banks. Our analysis suggests that there is potential for the euro to play a bigger role in EU-Asia trade links, which will be underpinned by the collective importance of Euroland as a much-enlarged trading and investment partner for Asia. However, in the short term at least, Asian equity markets are unlikely to benefit from significant inflows of capital from the EU as the former have been decimated by the region's financial crisis. As for Asian bond markets, rapid deterioration of sovereign ratings of countries in the region over the past 12 months would make it difficult for Asian companies to raise funds through euro-denominated debt instruments. As for official foreign exchange reserves, the bulk of Asian reserves is currently held in US dollar assets. Judging from Asian trade and debt figures, it seems unlikely that the euro would challenge the US dollar as a reserve currency any time in the near future. Nevertheless, in the longer term, the euro's introduction could make it easier for Asian central banks to diversify their reserves from the greenback to the euro. The internationalization of the euro is likely to happen only gradually, whether in terms of international trade denomination and settlement, denominating international financial assets, or as a reserve currency. Since the magnitude of shock that the single European currency would bring to the international monetary system is still unknown, only very tentative conclusions for the impact on Asian countries can be drawn at this point in time.     

Sovereign default, interest rates and political uncertainty in emerging markets

A large body of the empirical literature shows that high turnover rates/length of tenure of policymakers and the degree of conflict within a country affects sovereign spreads, debt and default rates. We help to rationalize such claims by including these political features in a dynamic stochastic small open economy model of sovereign debt and default. In this way we offer a complementary approach to the econometric analyses in the literature. Consistent with the data, the quantitative analysis shows that politically unstable and more polarized economies experience higher default rates and larger level and volatility of sovereign interest rate spreads.     

Fighting debt explosion in the European sovereign debt crisis

A number of tools have been suggested for solving the European sovereign debt crisis, in particular the options of leveraging the EFSF/ESM, introducing Eurobonds and a European Troubled Asset Relief Programme (Euro-TARP). However, it is unclear how these instruments will work, given jittery financial markets, the pending sovereign default of Greece and the fear of contagion among other countries. In the following paper, these policy tools will be analysed and evaluated with respect to their effects as well as their potential power to solve the debt crisis.     

The macroeconomic role of currency reserve accumulation in emerging markets—The Asian experience

The impact of currency reserve accumulation is controversially discussed since reserve accumulation potentially destabilises the international financial system and causes crises due to higher systemic risk. The main aim of this paper is to put the macroeconomic role of currency reserve accumulation for four Asian economies under closer scrutiny. The key question is whether accumulating currency reserves is beneficial from a long‐run perspective. Based on a vector error correction approach, we start by analysing long‐run steady‐state relationships between currency reserves, exchange rates against the US dollar, real GDP and interest rates. Our findings show that cumulated currency reserve shocks significantly affect real GDP . A likely explanation for our finding is that accumulation of reserves has supported growth through providing liquidity and supporting the development of the financial sector for the economies under observation.