Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment

Rohan Pitchford, Mark L. J. Wright
NBER Working Paper No. 16632
Issued in December 2010
NBER Program(s):   IFM


Why is it difficult to restructure sovereign debt in a timely manner? In this paper we present a theory of the sovereign debt restructuring process in which delay arises as individual creditors hold-up a settlement in order to extract greater payments from the sovereign. We then use the theory to analyze recent policy proposals aimed at ensuring equal repayment of creditor claims. Strikingly, we show that such collective action policies may increase delay by encouraging free-riding on negotiation costs, even while preventing hold-up and reducing total negotiation costs. A calibrated version of the model can account for observed delays, and finds that free riding is quantitatively relevant: whereas in simple low-cost debt restructuring operations collective mechanisms will reduce delay by more than 60%, in high-cost complicated restructuring the adoption of such mechanisms results in a doubling of delay.

Holdouts in Sovereign Debt Restructuring- A Theory of Negotiation in a Weak Contractual Environment

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