Essays on Sovereign Debt and Default
Adriana Cobas Barquet
Tesis, Doctorado en Economía, IE-PUC, 2020
Abstract: After the Russian default in 1998 and the subsequent new generation of debt crises, the economic literature of sovereign debt was eager to regain momentum.1 Three new topics captured academics’ attention. The exclusion from capital markets, which proved not to be permanent. The possibility to legally enforce the contracts to avoid increasing high profile litigations. The outbreak of collective action problems at debt restructuring processes on disintermediated debt. Thenceforth, the main advances in literature collected into
the following branches: theoretic quantitative models of debt, legal and microeconomic analysis of debt contracts and empirical analysis to different aspects of sovereign debt.
This dissertation contents two theoretical approaches nested within those topics, both focusing on processes that occur after default. The first one, aims to understand how the recent disintermediation of the sovereign debt market impacted on the outcome of debt restructuring. The second one, explores the non-negligible exclusion period after default, and the mechanisms that might explain the inactivity of the economy at capital markets once it successfully restructured defaulted debt.
The first chapter begins discussing some evidence of the recent disintermediation of sovereign debt market and explores the effects that this phenomenon produced on the restructuring process. In this new background, defaulting countries have had to confront mostly atomistic, unconnected bondholders when engaging on restructuring negotiations. According to the data, the nature of creditors did have an impact on the outcome of restructuring, and counterintuitively, the new conditions played against the government by reducing the
effective investors’ concession.
Hence, I propose a model to study the determination of the restructuring outcome (the haircut) when bondholders play a coordination game (a game in which the greatest benefits occur when players align their decisions). The resulting equilibrium multiplicity is solved using the global games approach. The main finding is that this new market setting entails a cost for the defaulting government: it works as an additional constraint which forces it to reduce the concession asked to creditors in order to increase the probability of the
program’s acceptance. I then compare my results with the restructuring outcome obtained with Nash bargaining, which is the main solution technique at quantitative debt models with endogenous restructuring. I find that under certain conditions, the haircut with the coordination feature stays below the Nash bargaining one for each possible value of the bargaining power. Finally, I run simulations with calibrated parameters for illustrative purposes and find that coordination costs account for a significant portion of the total haircut
reduction observed after the sovereign debt disintermediation process started.
The second chapter addresses the determinants of the exclusion period from capital markets which constitutes one of the main costs of defaults. The empirical literature states that almost half of this period is explained by the time it takes for the countries to re-access capital markets after they have restructured their debts. In particular, I focus on this second stage, which according the same authors, takes on average more than 7 years to solve. Henceforth, this chapter proposes a model to study the effects of issuance costs in the delay
of reentry once the economy has already restructured its debt. I build on a standard quantitative model of sovereign debt with return to capital markets introducing two modifications. First, I simplify the restructuring process which I am not targeting in the analysis and second, I introduce both fixed and variable issuance costs in the period of reentry.
In a calibrated version of the model, I find that both fixed and variable issuance costs at reentry help to better match the length of defaults observed in the data. First, these costs reduce the incentives to default ex ante. Thus, issuance costs result an interesting feature to introduce default costs other than the standard output loss function used in the literature. Second, the duration of the autarky period experiences a significant increase approaching the empirical levels. Indeed, as the economy does not control the endowment process, the
available decision is whether this is the proper moment to reentry capital markets given both the total amount of debt that can be raised and market prices. The delay here allows the economy to process a recovery in the endowment that results in the possibility of both issue more debt and get better prices. Finally, the model suggests that other default costs, that were not considered in restructuring negotiations and the economy expects to fund through new debt, might end up imposing a heavy burden that compromises the reentry to
capital markets thus extending the term of the financial exclusion.