Sovereign default resolution through maturity extension

Abstract

Sovereign default episodes are resolved by restructuring the debt through renegotiations and implemented by bond swaps and resumption of debt service payments. This process provides debt relief for the sovereign and partially compensates lenders for their losses. In the data, the bulk of such debt relief is implemented by extending the maturity of the debt rather than changing its face value. We augment a standard maturity choice model with a post-default renegotiation phase and study whether it can replicate this observed maturity extension. The model is successful in generating this and other key features of renegotiations and maturity choice, but critically only when we assume that sovereigns continue to be excluded temporarily from financial markets after renegotiation, consistent with the observation that countries do not immediately resume borrowing. In contrast, a version of the model where market access is restored promptly features a counterfactual reduction in maturity, a puzzle for the standard model.