The Dynamics of Sovereign Debt Crises and Bailouts

Abstract

Motivated by the recent European debt crisis, this paper investigates the scope for a bailout guarantee in a sovereign debt crisis. Defaults may arise from negative income shocks, government impatience or a "sunspot"-coordinated buyers strike. We introduce a bailout agency, and characterize the minimal actuarially fair intervention that guarantees the no-buyers-strike fundamental equilibrium, relying on the market for residual financing. The intervention makes it cheaper for governments to borrow, inducing them borrow more, leaving default probabilities possibly rather unchanged. The maximal backstop will be pulled precisely when fundamentals worsen. JEL Classification Numbers: F34, F41.

A quantitative model of sovereign debt, bailouts and conditionality

“…3 Our paper builds on the recent quantitative sovereign debt literature, in particular Cuadra, Sanchez and Sapriza (2010) who develop a model with endogenous default risk and endogenous fiscal policy to rationalize the empirical fact that fiscal policy tends to move procyclically in emerging markets. Aguiar and Gopinath (2006) and Roch and Uhlig (2011) analyze the impact of bailouts on sovereign default risk where the latter focus on the case of a monetary union. While Aguiar and Gopinath (2006) and Roch and Uhlig (2011) abstract from conditionality, Boz (2011) rationales the quantitative properties of conditional IFI lending within a model of sovereign debt.…”

“…Aguiar and Gopinath (2006) and Roch and Uhlig (2011) analyze the impact of bailouts on sovereign default risk where the latter focus on the case of a monetary union. While Aguiar and Gopinath (2006) and Roch and Uhlig (2011) abstract from conditionality, Boz (2011) rationales the quantitative properties of conditional IFI lending within a model of sovereign debt. To model conditionality she assumes that the government acts under a higher rate of time preference leading to a more conservative debt policy.…”

The Seniority Structure of Sovereign Debt

“…Here, we study private and official defaults and creditor losses simultaneously and systematically, thus complementing a small but growing empirical literature focusing on official debts (see, Chauvin and Kraay (2005), Cheng et al (2016Cheng et al ( , 2017, and Reinhart and Trebesch (2016a, 2016b, 2019). The results shed doubt on the view that all official creditors are senior to private creditors (an assumption made by, among others, Corsetti et al, 2006;Boz, 2011;Fink and Scholl, 2016;Dellas and Niepelt, 2016;Roch and Uhlig, 2018). Moreover, we contribute to the literature by showing new haircut estimates on official sovereign debt (government-togovernment loans) on a broad sample covering more than 400 restructurings and spanning four decades (building on data by Tolvasaite, 2010, and Reinhart and Trebesch, 2019, and expanding the exercise by Cheng et al (2018)).…”

Money Markets, Collateral and Monetary Policy

“…For example, perhaps the private sector haircuts and high yields on certain sovereign bonds reflect a dysfunctional system or a bad equilibrium, which the ECB appropriately seeks to correct, see e.g. Roch and Uhlig (2018). Conversely, perhaps these haircuts are due to the the appropriate rational assessment of default risks of the underlying bonds, while the ECB haircuts are too small.…”