Credit Derivatives and Sovereign Debt Crises

43 Pages Posted: 25 Oct 2005 Last revised: 30 Oct 2010

See all articles by Benedikt Goderis

Benedikt Goderis

The Netherlands Institute for Social Research|SCP

Wolf Wagner

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM); Centre for Economic Policy Research (CEPR)

Date Written: October 1, 2006

Abstract

The new markets for credit derivatives allow for buying protection on sovereign debt. This paper considers the implications for sovereign debt crises. We show that the availability of credit protection lowers ex-ante debtor moral hazard by allowing a bondholder to improve his bargaining position in negotiations with the sovereign, thus forcing the sovereign to internalize more of the costs of a crisis. Moreover, we find that equilibrium protection does not hinder an efficient resolution of crises. We even identify situations where crisis resolution is improved by facilitating conditionality. Nevertheless, we show that a bondholder's choice of protection is not always socially optimal. In these cases, increasing the level of protection makes crisis resolution more efficient.

Keywords: credit derivatives, sovereign debt crisis, moral hazard

JEL Classification: F33, F34, G15, G14

Suggested Citation

Goderis, Benedikt and Wagner, Wolf, Credit Derivatives and Sovereign Debt Crises (October 1, 2006). Available at SSRN: https://ssrn.com/abstract=826644 or http://dx.doi.org/10.2139/ssrn.826644

Benedikt Goderis

The Netherlands Institute for Social Research|SCP ( email )

Rijnstraat 50
The Haag, 2515
Netherlands

Wolf Wagner (Contact Author)

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM) ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam, 3000 DR
Netherlands

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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