The Market Reaction to Legal Shocks and Their Antidotes: Lessons from the Sovereign Debt Market

38 Pages Posted: 29 May 2008

See all articles by Michael Bradley

Michael Bradley

Duke University - Fuqua School of Business

James D. Cox

Duke University School of Law

G. Mitu Gulati

Duke University School of Law

Date Written: May 27, 2008

Abstract

In October 2000 a hedge fund holding an unpaid debt claim won an enormous victory against the debtor, the Republic of Peru, through an opportunistic interpretation of the common pari passu clause by a Brussels court. This development was met by charges from policy makers and practitioners that the court's decision (its novel interpretation of the pari passu clause) would lead to a dramatic increase in the risks of holdout litigation faced by sovereign debtors. Over the ensuing years, multiple reform solutions were proposed including the revision of certain contractual terms, the filing of amicus briefs in a key case, and the imposition of an international bankruptcy regime for sovereigns. The question, looking back, that this Article empirically investigates is whether the capital markets actually perceived a significant increase in risk at the time of the October 2000 Brussels court decision. Equally important is whether markets discriminate among competing versions of the pari passu clause based on their relative risks for holdouts. And, to the extent the markets did react to the increase in legal risk, did any of the antidotes that were implemented to reduce the supposed increased holdout risk work? We offer evidence that bond prices did respond to this legal shock, that markets do discriminate based on the relative holdout risk posed by differing forms of the pari passu clause, and provide surprising evidence regarding the efficacy of the government-sponsored antidote, the advent of collective action clauses.

Suggested Citation

Bradley, Michael and Cox, James D. and Gulati, Gaurang Mitu, The Market Reaction to Legal Shocks and Their Antidotes: Lessons from the Sovereign Debt Market (May 27, 2008). Duke Law School Public Law & Legal Theory Paper No. 211. Available at SSRN: https://ssrn.com/abstract=1138801 or http://dx.doi.org/10.2139/ssrn.1138801

Michael Bradley (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-8006 (Phone)
919-660-7971 (Fax)

James D. Cox

Duke University School of Law ( email )

210 Science Drive
Box 90362
Durham, NC 27708
United States
919-613-7056 (Phone)
919-613-7231 (Fax)

Gaurang Mitu Gulati

Duke University School of Law ( email )

210 Science Drive
Box 90362
Durham, NC 27708
United States

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