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Debt dilution and seniority in a model of defaultable sovereign debt

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  • Satyajit Chatterjee
  • Burcu Eyigungor

Abstract

An important ineffciency in sovereign debt markets is debt dilution, wherein sovereigns ignore the adverse impact of new debt on the value of existing debt and, consequently, borrow too much and default too frequently. A widely proposed remedy is the inclusion of seniority clause in sovereign debt contracts: Creditors who lent first have priority in any restructuring proceedings. We incorporate seniority in a quantitatively realistic model of sovereign debt and find that seniority is quite effective in mitigating the dilution problem. We also show theoretically that seniority cannot be fully effective unless the costs of debt restructuring are zero.

Suggested Citation

  • Satyajit Chatterjee & Burcu Eyigungor, 2013. "Debt dilution and seniority in a model of defaultable sovereign debt," Working Papers 13-30, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:13-30
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. A solution to sovereign debt dilution
      by Economic Logician in Economic Logic, Too on 2014-01-20 23:40:00
    2. [経済]ソブリン危機を避ける一法
      by himaginary in himaginaryの日記 on 2012-07-12 12:00:00
    3. Avoiding sovereign debt dilution with debt seniority
      by Economic Logician in Economic Logic on 2012-07-10 19:04:00

    Citations

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    Cited by:

    1. Juan Carlos Hatchondo & Leonardo Martinez & Francisco Roch, 2022. "Fiscal Rules and the Sovereign Default Premium," American Economic Journal: Macroeconomics, American Economic Association, vol. 14(4), pages 244-273, October.
    2. Jeon, Kiyoung & Kabukcuoglu, Zeynep, 2018. "Income inequality and sovereign default," Journal of Economic Dynamics and Control, Elsevier, vol. 95(C), pages 211-232.
    3. Rancière, Romain & Catão, Luís & Fostel, Ana, 2013. "Fiscal Discoveries and Sudden Decouplings," CEPR Discussion Papers 9368, C.E.P.R. Discussion Papers.
    4. Jesse Perla & Carolin Pflueger & Michal Szkup, 2020. "Doubling Down on Debt: Limited Liability as a Financial Friction," NBER Working Papers 27747, National Bureau of Economic Research, Inc.
    5. Luis Catão & Ana Fostel & Romain Ranciere, 2017. "Fiscal Discoveries and Yield Decouplings," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 65(4), pages 704-744, November.
    6. Juliana Salomao, 2015. "Sovereign Debt Renegotiation and Credit Default Swaps," 2015 Meeting Papers 826, Society for Economic Dynamics.
    7. Perez, Diego J., 2017. "Sovereign debt maturity structure under asymmetric information," Journal of International Economics, Elsevier, vol. 108(C), pages 243-259.
    8. Juan Carlos Hatchondo & Leonardo Martinez & César Sosa-Padilla, 2016. "Debt Dilution and Sovereign Default Risk," Journal of Political Economy, University of Chicago Press, vol. 124(5), pages 1383-1422.
    9. Aubhik Khan & Soyoung Lee, 2023. "Persistent Debt and Business Cycles in an Economy with Production Heterogeneity," Staff Working Papers 23-17, Bank of Canada.
    10. Alessandro Dovis, 2013. "Efficient Sovereign Default," 2013 Meeting Papers 293, Society for Economic Dynamics.
    11. Salomao, Juliana, 2017. "Sovereign debt renegotiation and credit default swaps," Journal of Monetary Economics, Elsevier, vol. 90(C), pages 50-63.
    12. Zuzana Mucka & Ludovit Odor, 2018. "Optimal sovereign debt: Case of Slovakia," Working Papers Working Paper No. 3/2018, Council for Budget Responsibility.
    13. Waibel Michael, 2016. "Eurobonds: Legal Design Features," Review of Law & Economics, De Gruyter, vol. 12(3), pages 635-657, November.
    14. Aguiar, Mark & Amador, Manuel, 2014. "Sovereign Debt," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 647-687, Elsevier.
    15. Mark Aguiar & Manuel Amador, 2013. "Sovereign Debt: A Review," NBER Working Papers 19388, National Bureau of Economic Research, Inc.
    16. Sunder-Plassmann, Laura, 2018. "Writing off sovereign debt: Default and recovery rates over the cycle," Journal of International Money and Finance, Elsevier, vol. 81(C), pages 221-241.

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