Working Paper
Debt dilution and seniority in a model of defaultable sovereign debt
Abstract: An important ineffciency in sovereign debt markets is debt dilution, wherein sovereigns ignore the adverse impact of new debt on the value of existing debt and, consequently, borrow too much and default too frequently. A widely proposed remedy is the inclusion of seniority clause in sovereign debt contracts: Creditors who lent first have priority in any restructuring proceedings. We incorporate seniority in a quantitatively realistic model of sovereign debt and find that seniority is quite effective in mitigating the dilution problem. We also show theoretically that seniority cannot be fully effective unless the costs of debt restructuring are zero.
Keywords: Debt;
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File(s): File format is application/pdf https://www.philadelphiafed.org/-/media/frbp/assets/working-papers/2013/wp13-30.pdf
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Bibliographic Information
Provider: Federal Reserve Bank of Philadelphia
Part of Series: Working Papers
Publication Date: 2013
Number: 13-30