6533b7dafe1ef96bd126f52e
RESEARCH PRODUCT
The Case for Contingent Convertible Debt for Sovereigns
Andrea ConsiglioStavros A. ZeniosStavros A. ZeniosStavros A. Zeniossubject
050208 finance05 social sciencesDebt-to-GDP ratioRecourse debtFinancial systemDebtorExternal debtDebt restructuring0502 economics and businessInternal debtBusiness050207 economicsDebt levels and flowsSenior debtdescription
We make the case for sovereigns to issue contingent convertible bonds as a means to forestall debt crises. These instruments contractually stipulate payment standstill, contingent on a sovereign’s credit default swap spread breaching a distress threshold. This is a financial innovation solution to the lack of sovereign debt restructuring mechanisms, limiting ex ante the likelihood of debt crises and imposing ex post risk sharing between creditors and the debtor. The new instruments are contingent contracts addressing neglected risks in sovereign debt. Building on literature for contingent convertible debt for banks we address the design of sovereign contingent debt, including market discipline and sovereign incentives; market manipulation and multiple equilibria; errors of false alarms or missed crises. Then we develop a risk optimization model to incorporate contingent debt in the portfolio of instruments financing a sovereign. Using Greece as a case study we illustrate Pareto improvements in expected cost vs tail risk.
| year | journal | country | edition | language |
|---|---|---|---|---|
| 2015-01-01 | SSRN Electronic Journal |