Debt Dilution and Seniority in a Model of Defaultable Sovereign Debt

46 Pages Posted: 23 Jul 2013

See all articles by Satyajit Chatterjee

Satyajit Chatterjee

Federal Reserve Bank of Philadelphia

Burcu Eyigungor

Federal Reserve Bank of Philadelphia

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2013

Abstract

An important ineffciency in sovereign debt markets is debt dilution, wherein sovereigns ignore the adverse impact of new debt on the value of existing debt and, consequently, borrow too much and default too frequently. A widely proposed remedy is the inclusion of seniority clause in sovereign debt contracts: Creditors who lent first have priority in any restructuring proceedings. We incorporate seniority in a quantitatively realistic model of sovereign debt and find that seniority is quite effective in mitigating the dilution problem. We also show theoretically that seniority cannot be fully effective unless the costs of debt restructuring are zero.

Keywords: Debt Dilution, Seniority, Sovereign Default

JEL Classification: E44, F34, G12, G15

Suggested Citation

Chatterjee, Satyajit and Eyigungor, Burcu, Debt Dilution and Seniority in a Model of Defaultable Sovereign Debt (July 1, 2013). FRB of Philadelphia Working Paper No. 13-30. Available at SSRN: https://ssrn.com/abstract=2296845 or http://dx.doi.org/10.2139/ssrn.2296845

Satyajit Chatterjee (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
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HOME PAGE: http://sites.google.com/site/chatterjeesatyajit/home

Burcu Eyigungor

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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