## Debt Seniority and Sovereign Debt Crises

_IMF Working Papers, May 9, 2018_

## Source details

**Canonical URL:** [Debt Seniority and Sovereign Debt Crises](https://www.imf.org/en/publications/wp/issues/2018/05/09/debt-seniority-and-sovereign-debt-crises-45840)

## Other formats

- [Markdown version](/en/publications/wp/issues/2018/05/09/debt-seniority-and-sovereign-debt-crises-45840/index.md)
- [Structured JSON version](/en/publications/wp/issues/2018/05/09/debt-seniority-and-sovereign-debt-crises-45840/index.json)
- [Bundle manifest](/en/publications/wp/issues/2018/05/09/debt-seniority-and-sovereign-debt-crises-45840/bundle-manifest.json)

## Bibliographic details
- Authors: Anil Ari, Giancarlo Corsetti, Luca Dedola
- Published: May 9, 2018
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484353691.001

---

### Research question and model
- Research question: Is the seniority structure of sovereign debt neutral for a government's decision between defaulting and raising surpluses?
- Model framework:
  - A model of debt crises with a discretionary government that endogenously chooses distortionary taxation and whether to apply an optimal haircut to bondholders.
  - Focus on the size of senior tranches and how seniority affects default incentives and repayment commitment.

### Key findings
- When the size of senior tranches is small:
  - A version of the Modigliani-Miller theorem holds: tranching redistributes government revenues from junior to senior bondholders, while taxes and government borrowing costs remain unchanged.
- When senior tranches become sufficiently large:
  - Default costs on senior debt generate a stronger commitment to repay not only the senior tranche but also the junior tranche.
- Existence of thresholds related to senior tranche size:
  - There is a lower threshold for senior bonds above which tranching can eliminate default on both junior and senior debt.
  - There is an upper threshold beyond which the government defaults also on senior debt.

### Policy implications and interpretation
- Seniority design matters for sovereign debt outcomes when senior tranches are large enough to affect default costs and repayment incentives.
- Tranching can be neutral (pure redistribution across bondholders) or can substantially alter default behavior depending on senior tranche size relative to the identified thresholds.
- Understanding the position of a sovereign’s senior tranche size relative to the lower and upper thresholds is critical for anticipating whether debt seniority will reduce, have no effect on, or exacerbate sovereign default risk.

---

## Content in this bundle

- **Debt Seniority and Sovereign Debt Crises, WP/18/104, May 2018**
  - [Debt Seniority and Sovereign Debt Crises, WP/18/104, May 2018 (Markdown version)](/-/media/files/publications/wp/2018/wp18104.pdf.md){rel="alternate" type="text/markdown"}
  - [Debt Seniority and Sovereign Debt Crises, WP/18/104, May 2018 (PDF)](/-/media/files/publications/wp/2018/wp18104.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2018/05/09/debt-seniority-and-sovereign-debt-crises-45840_