{
  "title": "Sovereign Cocos",
  "publication": "IMF Working Papers, April 29, 2022",
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  "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.",
  "sections": [
    {
      "heading": "Summary",
      "content": "- Model of equilibrium sovereign default where 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.\n- Introducing cocos reduces the frequency of defaults triggered by liquidity shocks but increases the overall default frequency.\n- By mitigating concerns about liquidity, cocos make indebtedness and default risk more attractive for the government.\n- Cocos that stipulate debt forgiveness when the government faces the shock achieve larger welfare gains by reducing default risk."
    },
    {
      "heading": "Key findings",
      "content": "- Cocos that convert to a suspension of debt payments:\n  - Reduce defaults that are specifically triggered by liquidity shocks (bondholders' risk aversion increases).\n  - Increase the overall frequency of default because the government chooses higher indebtedness and faces greater default incentives.\n- Cocos that stipulate debt forgiveness when the shock occurs:\n  - Achieve larger welfare gains compared with suspension-type cocos.\n  - Reduce default risk more effectively than suspension-type cocos."
    },
    {
      "heading": "Policy implications and considerations",
      "content": "- Design of contingent convertible sovereign instruments matters for default outcomes:\n  - Suspension-triggered cocos can backfire by encouraging higher government indebtedness and raising overall default frequency.\n  - Forgiveness-triggered cocos can be more effective at lowering default risk and improving welfare.\n- Policymakers should weigh liquidity-mitigation benefits against moral hazard and incentives for higher indebtedness when evaluating cocos as a sovereign liability-management tool."
    },
    {
      "heading": "Subjects and keywords (as given)",
      "content": "- Subject: Asset and liability management, Consumption, Contingent convertible capital, Debt default, Debt relief, External debt, Financial sector policy and analysis, National accounts, Return on investment\n- Keywords: Consumption, Contingent convertible capital, Debt default, debt payment, Debt relief, default frequency, default risk, Global, government issues coco, haircuts., liquidity shock, maturity extensions, reprofiling, Return on investment, risk-premium shock, Sovereign Cocos\n\n---\n\n Content in this bundle\n\n- Working Paper\n  - Working Paper (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - Working Paper (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2022/04/29/sovereign-cocos-517464"
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    "Authors: Juan Carlos Hatchondo, Leonardo Martinez, Kursat Onder, Francisco Roch",
    "Published: April 29, 2022",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9798400207648.001",
    "Model of equilibrium sovereign default where 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.",
    "Introducing cocos reduces the frequency of defaults triggered by liquidity shocks but increases the overall default frequency.",
    "By mitigating concerns about liquidity, cocos make indebtedness and default risk more attractive for the government.",
    "Cocos that stipulate debt forgiveness when the government faces the shock achieve larger welfare gains by reducing default risk.",
    "Cocos that convert to a suspension of debt payments:",
    "Cocos that stipulate debt forgiveness when the shock occurs:",
    "Design of contingent convertible sovereign instruments matters for default outcomes:",
    "Policymakers should weigh liquidity-mitigation benefits against moral hazard and incentives for higher indebtedness when evaluating cocos as a sovereign liability-management tool.",
    "Subject: Asset and liability management, Consumption, Contingent convertible capital, Debt default, Debt relief, External debt, Financial sector policy and analysis, National accounts, Return on investment",
    "Keywords: Consumption, Contingent convertible capital, Debt default, debt payment, Debt relief, default frequency, default risk, Global, government issues coco, haircuts., liquidity shock, maturity extensions, reprofiling, Return on investment, risk-premium shock, Sovereign Cocos",
    "**Working Paper**"
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