American Economic Review: Vol. 104 No. 5 (May 2014)


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Renegotiation Policies in Sovereign Defaults

Article Citation

Arellano, Cristina, and Yan Bai. 2014. "Renegotiation Policies in Sovereign Defaults." American Economic Review, 104(5): 94-100.

DOI: 10.1257/aer.104.5.94


This paper studies an optimal renegotiation protocol designed by a benevolent planner when two countries renegotiate with the same lender. The solution calls for recoveries that induce each country to default or repay, trading off the deadweight costs and the redistribution benefits of default independently of the other country. This outcome contrasts with a decentralized bargaining solution where default in one country increases the likelihood of default in the second country because recoveries are lower when both countries renegotiate. The paper suggests that policies geared at designing renegotiation processes that treat countries in isolation can prevent contagion of debt crises.

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Arellano, Cristina (Federal Reserve Bank of Minneapolis and U MN)
Bai, Yan (U Rochester)

JEL Classifications

H63: National Debt; Debt Management; Sovereign Debt

American Economic Review

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