Sovereign Cocos

Author/Editor:

Juan Carlos Hatchondo ; Leonardo Martinez ; Kursat Onder ; Francisco Roch

Publication Date:

April 29, 2022

Electronic Access:

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Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary:

We study a model of equilibrium sovereign default in which the government issues cocos (contingent convertible bonds) that stipulate a suspension of debt payments when the government faces liquidity shocks in the form of an increase of the bondholders' risk aversion. We find that in spite of reducing the frequency of defaults triggered by liquidity shocks, introducing cocos increases the overall default frequency. By mitigating concerns about liquidity, cocos make indebtedness and default risk more attractive for the government. In contrast, cocos that stipulate debt forgiveness when the government faces the shock, achieve larger welfare gains by reducing default risk.

Series:

Working Paper No. 2022/078

Subject:

Frequency:

regular

English

Publication Date:

April 29, 2022

ISBN/ISSN:

9798400207648/1018-5941

Stock No:

WPIEA2022078

Pages:

26

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