Coordination and Renegotiation: Sovereign Defaults in 1980s and 1990s

Features of sovereign debts restructuring in 1980s and 1990s are quite different in two aspects. One is that the renegotiation periods are longer in 1980s than in 1990s, in spite of the fact that sovereign borrowing in 1980s is mainly bank loans with several big creditors, while in 1990s it is mainly bonds with a large number of small creditors. The other is that the overall “haircut†(debt discharge) rate is higher in 1990s than in 1980s. In this paper we study these features using a game-theoretical model with coordination problems and repeated renegotiations. The key difference between 1980s and 1990s is the existence of secondary markets for bonds in 1990s. The markets play two roles. First, the liquidity of bonds lowers the reservation values of current bondholders. Second, the market prices offer higher precision of the signal on the reservation values of bondholders. The higher precision of signal produces a shorter period of renegotiation in the bond debt relative to the bank debt. The lower reservation value generates higher haircut rates in the bond debt relative to the bank debt. There exists a unique equilibrium in the economy with a large number of small bondholders in that only a fraction of them choose to hold out the bonds given the others accept the restructuring plan proposed by the government.