Duration of sovereign debt renegotiation

Sovereign debt renegotiations take an average of nine years for bank loans but only one year for bonds. Our paper provides an explanation to this finding by highlighting one key difference between bank loans and bonds: bank debt is rarely traded, while bond debt is heavily traded on the secondary market. The secondary market plays a crucial information revelation role in shortening renegotiations. Consider a dynamic bargaining game with incomplete information between a government and creditors. The creditors’ reservation value is private information, and the government knows only its distribution. Delays in reaching agreements arise in equilibrium because the government uses costly delays to screen the creditors’ reservation value. When the creditors trade on the secondary market, the market price conveys information about their reservation value, which lessens the information friction and reduces the renegotiation duration. We find that the secondary market tends to increase the renegotiation payoff of the government but decrease that of the creditors while increasing the total payoff. We then embed these renegotiation outcomes in a simple sovereign debt model to analyze the ex ante welfare implications. The secondary market has the potential to increase the government ex ante welfare when the information friction is severe. JEL: F02, F34, F51 Keyword: sovereign debt restructuring, secondary debt markets, dynamic bargaining, incomplete information ∗Bai: [email protected] †Zhang: [email protected] ‡We thank Cristina Arellano, Fernando Broner, V. V. Chari, Jonathan Eaton, Raquel Fernandez, Jonathan Heathcote, Patrick Kehoe, Timothy Kehoe, Narayana Kocherlakota, Natalia Kovrijnykh, Edward Prescott, Linda Tesar, Mark Wright, Vivian Yue, and seminar participants at Arizona State University, the Federal Reserve Bank of Minneapolis, the University of Michigan, New York University, and SED 2008 for their helpful comments and suggestions. All errors remain our own. 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.