Incentive-Compatible Sovereign Debt

Mario R. C. Bersem

Research output: Working paperResearch

Abstract

This paper presents a theory of sovereign borrowing and lending when there is no court to enforce repayment obligations. Specifically, I extend the costly state verification approach in financial contracting to include an ex-post repayment decision in which the borrower repays creditors to avoid repudiation costs. I derive the optimal loan contract, which I call “repudiation-proof debt,” and show how it saves on costly verification and avoids repudiation. Repudiation-proof debt can explain several key facts of sovereign borrowing: (i) why governments issue bonds in the first place; (ii) why strategic defaults occur even under the optimal loan contract; (iii) why such defaults are neither marginal nor total repudiation; and (iv) how repudiation costs mitigate sovereign risk and determine debt capacity in the absence of enforcement.
Original languageEnglish
Place of Publicationwww
PublisherSSRN: Social Science Research Network
Number of pages22
Publication statusPublished - 2012

Keywords

  • Soveriegn Debt
  • Costly State Verification
  • Financial Contracting
  • Repudiation Risk
  • Stategic Deafult

Cite this

Bersem, M. R. C. (2012). Incentive-Compatible Sovereign Debt. www: SSRN: Social Science Research Network.
Bersem, Mario R. C. / Incentive-Compatible Sovereign Debt. www : SSRN: Social Science Research Network, 2012.
@techreport{ebf04d3a593f49078e2747c7415c703f,
title = "Incentive-Compatible Sovereign Debt",
abstract = "This paper presents a theory of sovereign borrowing and lending when there is no court to enforce repayment obligations. Specifically, I extend the costly state verification approach in financial contracting to include an ex-post repayment decision in which the borrower repays creditors to avoid repudiation costs. I derive the optimal loan contract, which I call “repudiation-proof debt,” and show how it saves on costly verification and avoids repudiation. Repudiation-proof debt can explain several key facts of sovereign borrowing: (i) why governments issue bonds in the first place; (ii) why strategic defaults occur even under the optimal loan contract; (iii) why such defaults are neither marginal nor total repudiation; and (iv) how repudiation costs mitigate sovereign risk and determine debt capacity in the absence of enforcement.",
keywords = "Soveriegn Debt, Costly State Verification, Financial Contracting, Repudiation Risk, Stategic Deafult, Sovereign Debt, Costly State Verification, Financial Contracting, Repudiation Risk, Strategic Default",
author = "Bersem, {Mario R. C.}",
year = "2012",
language = "English",
publisher = "SSRN: Social Science Research Network",
type = "WorkingPaper",
institution = "SSRN: Social Science Research Network",

}

Bersem, MRC 2012 'Incentive-Compatible Sovereign Debt' SSRN: Social Science Research Network, www.

Incentive-Compatible Sovereign Debt. / Bersem, Mario R. C.

www : SSRN: Social Science Research Network, 2012.

Research output: Working paperResearch

TY - UNPB

T1 - Incentive-Compatible Sovereign Debt

AU - Bersem, Mario R. C.

PY - 2012

Y1 - 2012

N2 - This paper presents a theory of sovereign borrowing and lending when there is no court to enforce repayment obligations. Specifically, I extend the costly state verification approach in financial contracting to include an ex-post repayment decision in which the borrower repays creditors to avoid repudiation costs. I derive the optimal loan contract, which I call “repudiation-proof debt,” and show how it saves on costly verification and avoids repudiation. Repudiation-proof debt can explain several key facts of sovereign borrowing: (i) why governments issue bonds in the first place; (ii) why strategic defaults occur even under the optimal loan contract; (iii) why such defaults are neither marginal nor total repudiation; and (iv) how repudiation costs mitigate sovereign risk and determine debt capacity in the absence of enforcement.

AB - This paper presents a theory of sovereign borrowing and lending when there is no court to enforce repayment obligations. Specifically, I extend the costly state verification approach in financial contracting to include an ex-post repayment decision in which the borrower repays creditors to avoid repudiation costs. I derive the optimal loan contract, which I call “repudiation-proof debt,” and show how it saves on costly verification and avoids repudiation. Repudiation-proof debt can explain several key facts of sovereign borrowing: (i) why governments issue bonds in the first place; (ii) why strategic defaults occur even under the optimal loan contract; (iii) why such defaults are neither marginal nor total repudiation; and (iv) how repudiation costs mitigate sovereign risk and determine debt capacity in the absence of enforcement.

KW - Soveriegn Debt

KW - Costly State Verification

KW - Financial Contracting

KW - Repudiation Risk

KW - Stategic Deafult

KW - Sovereign Debt

KW - Costly State Verification

KW - Financial Contracting

KW - Repudiation Risk

KW - Strategic Default

M3 - Working paper

BT - Incentive-Compatible Sovereign Debt

PB - SSRN: Social Science Research Network

CY - www

ER -

Bersem MRC. Incentive-Compatible Sovereign Debt. www: SSRN: Social Science Research Network. 2012.