Essays on sovereign debt

Wang, Zilong (2016) Essays on sovereign debt. PhD thesis, University of Nottingham.

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Abstract

This thesis analyzes various issues of sovereign debt from both theoretical and empirical perspectives. The first chapter investigates how global and country-specific factors like US interest rates, global risk aversion and the country-specific macroeconomic climate drive the dynamics of sovereign spreads in emerging countries. I develop a theoretical framework that pinpoints the determination of the equilibrium debt level, probability of default and sovereign spread, and test empirical implications derived from the predictions of the model. The chapter then employs a Structural Vector Autoregression (SVAR) model to show empirically how the spread of sovereign debt is influenced over time by the factors given above. The empirical results show that most of the variations in sovereign spreads are caused by global shocks such as the term structure of US interest rates and the global risk aversion. The findings also indicate that shocks from the US have a direct effect on sovereign spread and an indirect effect via country-specific macroeconomic fundamentals. Finally, the evidence produced validates the presence of some response patterns of sovereign spread to the global shocks.

The second chapter deals with debt restructuring strategy from private initiatives when multiple players are involved. I show that when the old creditor is unable to extend new loans due to liquidity crunch and austerity, and incentive issues of the borrowing country worsen sovereign debt repayment problems, a debt equity swap where an old creditor swaps a part of the debt for an equivalent amount of equity is Pareto improving and benefits all stakeholders. The exchange of old debt into equity makes the new debt automatically more senior as the extra equity (swapped) is by definition junior to all other debt. The enhanced priority of the new debt increases the pay-off of new lenders in the bad state and makes this debt relatively safer and allows lenders to charge lower interest rates. This fall in the face value of new loans (payments in the good state) leaves an increased surplus to the borrowing country, which is then incentivized to make an extra effort to make risky project successful, which further lowers the probability of second time default, making everyone’s gains ex ante. Thus, unlike previous work on debt equity swap models which show ambiguous increments in welfare, my work shows the opposite when such swaps are designed in the debt restructuring process. My model further discusses why such swaps are most effective in the current European debt crisis. Finally, my model shows that debt exchange, where the old creditor exchanges its existing debt into a new junior debt, is Pareto improving.

The third chapter empirically analyses the effect of participating in an IMF program on sovereign debt rescheduling. By applying simultaneous equation estimation for 115 countries from 1970 to 2012, I found that participating in a non-concessional IMF program increases the probability of subsequent debt rescheduling, but the probability and the quantity of debt rescheduling are negatively correlated with the amount of non-concessional IMF disbursed loans in the short term. The participation effect of IMF programs on sovereign debt rescheduling is larger for countries with a lower income. Furthermore, compliance with IMF conditionality could increase the probability and quantity of subsequent debt rescheduling, especially for low income countries. The results may indicate that participation in a non-concessional IMF program could signal a country’s willingness to reform and that the recipient country is rewarded with subsequent debt rescheduling. The effectiveness of signaling is negatively linked to the country’s level of income and compliance with IMF conditionality could enhance such signaling effects.

Item Type: Thesis (University of Nottingham only) (PhD)
Supervisors: Banerji, Sanjay
Bai, Ye
Subjects: H Social sciences > HG Finance
Faculties/Schools: UK Campuses > Faculty of Social Sciences, Law and Education > Nottingham University Business School
Item ID: 32670
Depositing User: Wang, Zilong
Date Deposited: 18 Jul 2016 06:40
Last Modified: 15 Sep 2016 07:15
URI: http://eprints.nottingham.ac.uk/id/eprint/32670

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