Seminar

Take the Short Route: How to Repay Sovereign Debt with Multiple Maturities

Mark Aguiar (University of Princeton)

June 24, 2013, 17:00–18:30

Toulouse

Room MS 001

Political Economy Seminar

Abstract

We address the question of whether and how a sovereign should reduce its external indebtedness when default is a possibility, with a particular focus on whether a government should buy back or dilute existing long-term sovereign bonds. Our main finding is that when deleveraging is optimal, the government should remain passive in the long-term bond market, retiring long-term bonds as the mature but never actively issuing or buying back these bonds on the secondary market. The only active margin is the short-term bond market, which involves partial roll over of such debt. Any active maturity management, as will typically be required to address roll over crisis risk, will be delayed until the end of the deleveraging process. The result relies on the fact that long-term bonds generate a time consistency problem, making their prices particularly sensitive to the incentives to save going forward. This, combined with the model's implication that short-term debt provides a greater incentive to save, implies that active maturity management shrinks the governments budget set. There exist a set of Pareto improving debt restructurings in which maturities are shortened; however, these cannot be implemented by trading in competitive secondary markets.