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Optimal Maturity Structure of Sovereign Debt in Situation of Near Default
Author:
Gabriel Desgranges null

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Ms. Celine Rochon
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Series:
IMF Working Papers
Volume/Issue:
Volume 2014: Issue 168
Language:
English
Publication Date:
12 Sep 2014
DOI:
https://doi.org/10.5089/9781498379779.001
ISBN:
9781498379779
ISSN:
1018-5941
Pages:
43
Keywords:
WP; interest rate; Lt debt; optimal portfolio
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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We study the relationship between default and the maturity structure of the debt portfolio of a Sovereign, under uncertainty. The Sovereign faces a trade-off between a future costly default and a high current fiscal effort. This results into a debt crisis in case a large initial issuance of long term debt is followed by a sequence of negative macro shocks. Prior uncertainty about future fundamentals is then a source of default through its effect on long term interest rates and the optimal debt issuance. Intuitively, the Sovereign chooses a portfolio implying a risk of default because this risk generates a correlation between the future value of long term debt and future fundamentals. Long term debt serves as a hedging instrument against the risk on fundamentals. When expected fundamentals are high, the Sovereign issues a large amount of long term debt, the expected default probability increases, and so does the long term interest rate.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund