The Long and the Short of It: Sovereign Debt Crises and Debt Maturity

• Authors: Raquel Fernández and Alberto Martin.
• BSE Working Paper: 112114 | September 15
• Keywords: sovereign debt , dilution , optimal maturity , restructuring , reprofiling , IMF
• JEL codes: F33, F34, F36, F41, G1
• sovereign debt
• dilution
• optimal maturity
• restructuring
• reprofiling
• IMF

We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent nor renegotiated. We show that in order to satisfy incentive compatibility the country must issue short-term debt, which exposes it to roll-over crises and inefficient repayments. We examine two policies – restructuring and reprofiling – and show that both improve ex ante welfare if structured correctly. Key to the welfare results is the country’s ability to choose its debt structure so as to neutralize any negative effect resulting from the redistribution of payments across creditors in times of crises.