Collateral Constraints, Debt Management and Investment Incentives

This paper analyses the hedging decisions of an emerging economy which is exposed to market risks and whose debt contract is subject to collateral constraints. Within a sovereign debt model with default risk and endogenous collateral, we study the optimal choice of hedging instruments when both futures and non-linear derivatives are available. We examine in which way the hedging policy is affected by the cost of default and the financial constraints of the economy and provide some implications in terms of resource allocation.