Essays on Sovereign Debt: Default, Settlement, and Repayment History

Abstract

This dissertation consists of two essays and studies topics on sovereign debt. The first essay analyzes, using duration models, the factors that affect the length of time a country in default is excluded from the international credit markets. It shows that disclosure of information by the debtor will lead to a reduction in the time of the negotiation; that is, an increase in the settlement rate. This disclosure of information can be in the form of previous default or the credible announcement of fiscal reforms. Engaging in debt reduction or rescheduling under concessionary rates hurts the debtor's probability of reaching an agreement and settling the debt. The second essay proposes a dynamic model of sovereign debt that combines default, settlement, and repayment history. The model addresses two questions: 1) how level of debt and income profile affect the length of time a country in default is excluded from the international credit market, and 2) how repayment history shapes the credit limit and interest rate lenders offer, and the borrower's incentive to default. In the model, borrowers weigh the benefits from defaulting against the penalties associated with it, namely a lengthy exclusion from the market and a potential deterioration in the credit terms. The settlement is modeled as a random process conditioned on the portion of the defaulted debt borrowers agree to repay. The model incorporates repayment history into the information set used by lenders. Quantitative analysis shows that the model can replicate some key stylized facts of sovereign debt: 1) settlement offers depend positively on a debtor's current income level and negatively on its level of debt; 2) the debt-to-GDP ratio that new borrowers or serial defaulters can support is well below the ratio that proven debtors can safely manage; 3) the probability of default is larger for debtors with recent payment difficulties; 4) once a country defaults, it takes many years of flawless repayment and low levels of debt for that country to gain continuous access to international credit markets at low cost; this process is slow and backsliding into default is difficult to avoid.