Optimal Maturity Structure of Sovereign Debt in Situation of Near Default

Author/Editor:

Gabriel Desgranges ; Celine Rochon

Publication Date:

September 12, 2014

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

We study the relationship between default and the maturity structure of the debt portfolio of a Sovereign, under uncertainty. The Sovereign faces a trade-off between a future costly default and a high current fiscal effort. This results into a debt crisis in case a large initial issuance of long term debt is followed by a sequence of negative macro shocks. Prior uncertainty about future fundamentals is then a source of default through its effect on long term interest rates and the optimal debt issuance. Intuitively, the Sovereign chooses a portfolio implying a risk of default because this risk generates a correlation between the future value of long term debt and future fundamentals. Long term debt serves as a hedging instrument against the risk on fundamentals. When expected fundamentals are high, the Sovereign issues a large amount of long term debt, the expected default probability increases, and so does the long term interest rate.

Series:

Working Paper No. 2014/168

Subject:

Debt burden Debt default Hedging Public debt Tax incentives

English

Publication Date:

September 12, 2014

ISBN/ISSN:

9781498379779/1018-5941

Stock No:

WPIEA2014168

Pages:

43

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