TY - JOUR
T1 - Writing off sovereign debt
T2 - Default and recovery rates over the cycle
AU - Sunder-Plassmann, Laura
PY - 2018/3
Y1 - 2018/3
N2 - This paper studies the joint determination of sovereign borrowing, default and debt restructuring outcomes. In the data, low debt recovery rates are associated with deep recessions in defaulting countries, high indebtedness at the time of default, and high borrowing costs post-default. I develop a dynamic model of sovereign debt to account for these facts. Recovery rates in the model are determined as the result of two countervailing forces: Cyclical conditions which reduce recovery rates in recessions, and procyclical borrowing which has the opposite effect. The former needs to be sufficiently strong for the model to match the data, and I present empirical evidence and a theoretical rationale for such excess sensitivity of restructuring outcomes to cyclical conditions in the form of countercyclical bargaining power of the sovereign. In the calibrated model, I show that accounting for the cyclicality of recoveries is important for correctly predicting the timing of default events. Procyclical and low recovery rates are detrimental for welfare, but the gains from eliminating the cyclicality are more than twice as high as those from raising average recovery rates.
AB - This paper studies the joint determination of sovereign borrowing, default and debt restructuring outcomes. In the data, low debt recovery rates are associated with deep recessions in defaulting countries, high indebtedness at the time of default, and high borrowing costs post-default. I develop a dynamic model of sovereign debt to account for these facts. Recovery rates in the model are determined as the result of two countervailing forces: Cyclical conditions which reduce recovery rates in recessions, and procyclical borrowing which has the opposite effect. The former needs to be sufficiently strong for the model to match the data, and I present empirical evidence and a theoretical rationale for such excess sensitivity of restructuring outcomes to cyclical conditions in the form of countercyclical bargaining power of the sovereign. In the calibrated model, I show that accounting for the cyclicality of recoveries is important for correctly predicting the timing of default events. Procyclical and low recovery rates are detrimental for welfare, but the gains from eliminating the cyclicality are more than twice as high as those from raising average recovery rates.
KW - Faculty of Social Sciences
KW - Sovereign default
KW - Debt restructuring
KW - Debt recovery rates
U2 - 10.1016/j.jimonfin.2017.11.014
DO - 10.1016/j.jimonfin.2017.11.014
M3 - Journal article
SN - 0261-5606
VL - 81
SP - 221
EP - 241
JO - Journal of International Money and Finance
JF - Journal of International Money and Finance
ER -