Debt relief and debt rescheduling: The optimal-contract approach

Abstract

In this paper we study the implications of assuming that bank syndicates and debtor countries entered into implicit debt contracts during the 1970s. Our approach rests on the assumption that loan contracts charged a risk premium because banks entertained the possibility of borrowers' default. Contrary to the previous literature on sovereign debt and debt-overhang, we assume full coordination between banks and debtors in designing optimal debt contracts. In this respect, we find that debt relief may actually be consistent with full-precommitment situations. We present an application of the model to data from Argentina, Brazil, and Mexico.