Sunday, Jan. 7, 2018 10:15 AM - 12:15 PM
- Chair: Romain Ranciere, University of Southern California
Bailout Guarantees, Banking Crises and Sovereign Debt Crises
AbstractThis paper studies the link between banking crises, sovereign default and government guarantees. A banking crisis can lead to a domestic credit crunch, which can be mitigated by government guarantees. However, the provision of bailout guarantees exposes the government to potentially severe losses from a banking sector failure and a sharp rise in public debt, causing sovereign default risk, and thus sovereign spreads, to increase substantially. As a result, the value of government guarantees deteriorates, deepening the crisis in the financial sector. The recent bailout in Ireland clearly illustrates the relevance of such risk transmission mechanism. An additional important contribution of our paper is to determine under which circumstances it is desirable for the government to provide bailout guarantees to the financial sector of the economy. A calibrated version of our model can mimic some of the interaction dynamics between financial sector risks and sovereign risks observed in Ireland during the crisis.
Sovereign Cocos and the Reprofiling of Debt Payments
AbstractWe study a model of equilibrium sovereign default in which the government issues cocos (contingent convertible bonds) that stipulate a suspension of debt payments when the government has lost market access. We quantify the effects of such cocos by comparing simulations of the cocos model with the ones obtained when the government issues non-contingent debt. We find that cocos are more likely to mitigate sovereign risk and generate welfare gains when the suspension of payments is triggered by local shocks and accompanied by conditionality, and when cocos are complemented with fiscal rules. We also find that it may be optimal to complement the reprofiling of debt payments with haircuts.
Sovereign Bond Prices, Haircuts and Maturity
AbstractRejecting a common assumption in the sovereign debt literature, we document that creditor losses (“haircuts”) during sovereign restructuring episodes are asymmetric across debt instruments. We code a comprehensive dataset on instrument-specific haircuts for 28 debt restructurings with private creditors in 1999–2015 and find that haircuts on shorter-term debt are larger than those on debt of longer maturity. In a standard asset pricing model, we show that increasing short-run default risk in the run-up to a restructuring episode can explain the stylized fact. The data confirms the predicted relation between perceived default risk, bond prices, and haircuts by maturity.
- F4 - Macroeconomic Aspects of International Trade and Finance
- H3 - Fiscal Policies and Behavior of Economic Agents