Recovery Before Redemption: A Theory of Delays in Sovereign Debt Renegotiations

Abstract

Negotiations to restructure sovereign debts are protracted, taking on average almost 8 years to complete. In this paper we construct a new database (the most extensive of its kind covering ninety recent sovereign defaults) and use it to document that these negotiations are also ineffective in both repaying creditors and reducing the debt burden countries face. Specifically, we find that creditor losses average roughly 40 per-cent, and that the average debtor exits default more highly indebted than when they entered default. To explain this apparent large inefficiency in negotiations, we present a theory of sovereign debt renegotiation in which delay arises from the same commitment problems that lead to default in the first place. A debt restructuring generates surplus for the parties at both the time of settlement and in the future. However, a creditor's ability to share in the future surplus is limited by the risk that the debtor will default on the settlement agreement. Hence, the debtor and creditor find it privately optimal to delay restructuring until future default risk is low, even though delay means some gains from trade remain unexploited. We show that a quantitative version of our theory can account for a number of stylized facts about sovereign default, as well as the new facts about debt restructurings that we document in this paper. Finally, we argue that our findings shed light on the existence of delays in bargaining in a wider range of contexts.

Sovereign default and debt renegotiation

“…Aguiar and Gopinath (2007) and Arellano (2008) study the quantitative properties of an Eaton-Gersovitz type sovereign default model. 30 In 29 Benjamin and Wright (2009) find that the average length of renegotiation is 7.4 years. The delays in sovereign debt renegotiations after 1990 are on average a little over 2 years in these authors' sample.…”

“…However, through renegotiation over debt reduction, the defaulting country can regain its access to capital markets as in Fernandez and Rosenthal (1990). 5 At the same time, foreign lenders obtain the par- 2 See Chuhan and Sturzenegger (2003), Sturzenegger and Zettelmeyer (2005), Benjamin and Wright (2009), and Standard and Poor's for details of sovereign debt renegotiations since 1980.…”

Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation

“…For simplicity, the direct utility bene…t of repayment is taken as exogenous, unlike in the papers by Yue (2006), Pitchford and Wright (2007), and Benjamin and Wright (2009), who model these payments as the outcome of bargaining between creditors and debtors.…”

Sovereign Bond Prices, Haircuts and Maturity

“…6 SZ define the recovery rate (one minus the haircut) as the ratio of the net present values of two cash flow streams, a "new" one and an "old" one. The new cash flow stream reflects the contractually defined payments of the new debt instrument(s) received in the course of a debt exchange; the cash flows are discounted at the yield to maturity of the new instrument(s).…”