The Pricing of LDC Debt in the Secondary Market: An Empirical Analysis

Six years after the explosion of the LDCs’ debt crisis, little has been achieved in trying to solve this problem. So far the international financial community and the indebted LDCs have managed to ‘muddle through’ by means of debt reschedulings, debt forgiveness, IMF‐sponsored adjustment programs, and the invention of new financial instruments. Among the latter, prominent relevance has been recently gained by debt‐equity swaps. This paper deals with what debt‐equity swaps are, how they work, the main participants in the market where debt‐equity swaps are carried out, and how the price for LDC debt is determined in this market. Our findings are that the price is indeed determined by market forces (and not by psychological factors, as it is often implied in the press), thus creating a new set of policy options to pursue the use of debt‐equity swaps for reducing the LDCs’ external debt. Despite some drawbacks of this device, that are highlighted in the paper, our main conclusion is that debt‐equity swaps may represent a useful tool for “buying time” while waiting for both the LDCs and the developed countries to undertake policies aimed at the easing of the foreign debt burden in the LDCs.