Take the Short Route: Equilibrium Default and Debt Maturity

Mark Aguiar; Manuel Amador; Hugo Hopenhayn; Iván Werning

doi:10.3982/ECTA14806

Take the Short Route: Equilibrium Default and Debt Maturity

Mark Aguiar, Manuel Amador, Hugo Hopenhayn, Iván Werning

Economics (Twin Cities)

Research output: Contribution to journal › Article › peer-review

45 Scopus citations

Abstract

We study the interactions between sovereign debt default and maturity choice in a setting with limited commitment for repayment as well as future debt issuances. Our main finding is that, under a wide range of conditions, the sovereign should, as long as default is not preferable, remain passive in long-term bond markets, making payments and retiring long-term bonds as they mature but never actively issuing or buying back such bonds. The only active debt-management margin is the short-term bond market. We show that any attempt to manipulate the existing maturity profile of outstanding long-term bonds generates losses, as bond prices move against the sovereign. Our results hold regardless of the shape of the yield curve. The yield curve captures the average costs of financing at different maturities but is misleading regarding the marginal costs.

Original language	English (US)
Pages (from-to)	423-462
Number of pages	40
Journal	Econometrica
Volume	87
Issue number	2
DOIs	https://doi.org/10.3982/ECTA14806
State	Published - Mar 2019

Bibliographical note

Funding Information:
Mark Aguiar: [email protected] Manuel Amador: [email protected] Hugo Hopenhayn: [email protected] Iván Werning: [email protected] This paper draws on two previously circulated papers: “Equilibrium Default,” by the last two co-authors; and “Take the Short Route: How to Repay and Restructure Sovereign Debt With Multiple Maturities,” by the first two. We thank comments and suggestions from Fernando Alvarez, Andy Atkeson, Cristina Arellano, V.V. Chari, Raquel Fernandez, Emmanuel Farhi, Doireann Fitzgerald, Stephan Guibaud, Dirk Niepelt, Juan Pablo Nicolini, and Chris Phelan as well as several seminar participants. We are grateful to Georgios Stefanidis, who provided excellent research assistance. Manuel Amador acknowledges support from the Sloan Foundation and the NSF (award number 0952816). Hugo Hopenhayn and Iván Werning acknowledge support from NSF (award number 0922461). The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.

Publisher Copyright:
© 2019 The Econometric Society

Keywords

Sovereign debt
debt default
dilution
maturity choice

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10.3982/ECTA14806

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abstract = "We study the interactions between sovereign debt default and maturity choice in a setting with limited commitment for repayment as well as future debt issuances. Our main finding is that, under a wide range of conditions, the sovereign should, as long as default is not preferable, remain passive in long-term bond markets, making payments and retiring long-term bonds as they mature but never actively issuing or buying back such bonds. The only active debt-management margin is the short-term bond market. We show that any attempt to manipulate the existing maturity profile of outstanding long-term bonds generates losses, as bond prices move against the sovereign. Our results hold regardless of the shape of the yield curve. The yield curve captures the average costs of financing at different maturities but is misleading regarding the marginal costs.",

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N2 - We study the interactions between sovereign debt default and maturity choice in a setting with limited commitment for repayment as well as future debt issuances. Our main finding is that, under a wide range of conditions, the sovereign should, as long as default is not preferable, remain passive in long-term bond markets, making payments and retiring long-term bonds as they mature but never actively issuing or buying back such bonds. The only active debt-management margin is the short-term bond market. We show that any attempt to manipulate the existing maturity profile of outstanding long-term bonds generates losses, as bond prices move against the sovereign. Our results hold regardless of the shape of the yield curve. The yield curve captures the average costs of financing at different maturities but is misleading regarding the marginal costs.

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Take the Short Route: Equilibrium Default and Debt Maturity

Abstract

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