ADEMU Conference on Debt Sustainability and Lending Institutions

1. Discussion of: Self-Fullfilling Debt Restructuring
Juan Carlos Hatchondo
Indiana University

2. Cruces and Trebesch (2013):
Larger haircuts → post-settlement ∆ spread > 0.
Higher post-settlement ∆ spread is long-lasting.

3. Standard models feature positive relationship between debt and
spread, consistent with the data. ⇒ Ceteris paribus, higher
haircuts should lead to lower spread.
Finding in Cruces and Trebesch suggest
Settlements with higher haircuts occur in times with “bad” and
persistent shocks.
Bondholders take high haircut as a bad signal about future
repayment.
Punishment for larger haircuts?
Bad shock may not be low income. Benjamin and Wright (2013):
“... settlements tend to occur when output has returned to trend”
Benjamin and Wright (2013) find that post-settlement debt >
pre-default debt. Could account for higher post-settlement spread.

4. Story in this paper:
Persistent lenders’ coordination.
Lenders can coordinate on the good equilibrium (with lending) or
the bad equilibrium (with no lending and default).
Settlements in times with bad equilibrium ⇒ higher haircut and
higher post-settlement spread.
Quantitative model generates significant dispersion in haircuts.

5. V(b, y, s) = Max VR
(b, y, s), VD
(b, y, s) .
b = bonds maturing in current period. s ∈ {sL, sH} sunspot variable.
VR
(b, y, s) = Max
b
u(c) + βEy ,s |y,sV(b , y , s )
s.t. c = y − b + q(b , y, s)b
VD
(b, y, s) = u(y − L(y)) + β θEy ,s |y,sV(b , y , s ) + (1 − θ) VD
(b , y , s )
Negotiation in every default period:
b = Argmax
x
VD(x, y, s) − VAut(y)
u (y − L(y))
α
[qD(x, y, s)x]1−α
qD price of a bond in default: may remain in default next period.

6. Understanding link between recovery and post-settlement spread
can be useful to understand pre-default behavior.
What are the implications of the basic model without Cole-Kehoe
crises?
Sunder-Plassmann (2016) find in a standard model with only
income shocks: higher haircut associated with lower spread.
Is it also the case with this parameterization?
CK crises derive from a shock to borrowing opportunities. Could
document link between haircut, spread, and measures of global
risk premium.

7. MODELING CHOICES
Why countries do not exit the default after settling? Model
assumes the borrower exits the default with probability θ.
Why not let government decide when to settle? Model assumes
that borrower and lenders have to negotiate in every default
period.
Could try modeling of Aguiar et al. (2016). Currently sunspot
realization is also associated with future sunspot distributions.

8. MODELING CHOICES
Why countries do not exit the default after settling? Model
assumes that exit the default with probability θ.
Why not let government decide when to settle? Model assumes
that borrower and lenders have to negotiate in every default
period.
Could try model of Aguiar et al. (2016). Currently sunspot
realization is also associated with future sunspot distributions.

9. QUANTITATIVE EXERCISE
Model
Debt / y 59.6
Def. freq. 2.1
Mean spread 12.5
std dev spread 65.2
Difference between spread and default probability: sample
selection?
Standard deviation of the spread is too high.
Rollover risk may be too high: one-period debt. Consumption
volatility?
Long-term debt could also enhance quantitative performance.

10. EXPOSITION
Value added of CK crises?
Need a graph linking distribution of haircuts with distribution of
post-settlement spread.
Illustration of the mechanism that links sunspot realizations to
haircuts. Some assumptions in the 3 period model are
endogenous outcomes.
How do bond price schedules and choices depend on the sunspot
shock?