SOVEREIGN DEBT The Robert W. Kolb Series in Finance provides a comprehensive view of the field of finance in all of its variety and complexity. The series is projected to include approximately 65 volumes covering all major topics and specializations in finance, ranging from investments, to corporate finance, to financial institutions. Each vol- ume in the Kolb Series in Finance consists of new articles especially written for the volume. Each volume is edited by a specialist in a particular area of finance, who devel- ops the volume outline and commissions articles by the world’s experts in that particular field of finance. Each volume includes an editor’s introduction and ap- proximately thirty articles to fully describe the current state of financial research and practice in a particular area of finance. The essays in each volume are intended for practicing finance professionals, grad- uate students, and advanced undergraduate students. 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Kolb, Robert W., 1949- HJ8015.S68 2011 336.3’4–dc22 2010043306 Printed in the United States of America 10987654321 To Lori, my sovereign Contents Introduction xiii Acknowledgments xxiii PART I The Political Economy of Sovereign Debt 1 1 Sovereign Debt: Theory, Defaults, and Sanctions 3 Robert W. Kolb 2 The Institutional Determinants of Debt Intolerance 15 Raffaela Giordano and Pietro Tommasino 3 Output Costs of Sovereign Default 23 Bianca De Paoli, Glenn Hoggarth, and Victoria Saporta 4 Spillovers of Sovereign Default Risk: How Much Is the Private Sector Affected? 33 Udaibir S. Das, Michael G. Papaioannou, and Christoph Trebesch 5 Sovereign Debt Problems and Policy Gambles 43 Samuel W. Malone 6 Sovereign Debt and the Resource Curse 51 Mare Sarr, Erwin Bulte, Chris Meissner, and Swanson Tim 7 Sovereign Debt and Military Conflict 63 Zane M. Kelly PART II Making Sovereign Debt Work 71 8 Fiscal Policy, Government Institutions, and Sovereign Creditworthiness 73 Bernardin Akitoby and Thomas Stratmann vii viii Contents 9 Corruption and Creditworthiness: Evidence from Sovereign Credit Ratings 79 Craig A. Depken II, Courtney L. LaFountain, and Roger B. Butters 10 Institutions, Financial Integration, and Complementarity 89 Nicola Gennaioli, Alberto Martin, and Stefano Rossi 11 Loans versus Bonds: The Importance of Potential Liquidity Problems for Sovereign Borrowers 101 Issam Hallak and Paul Schure 12 First-Time Sovereign Bond Issuers: Considerations in Accessing International Capital Markets 111 Udaibir S. Das, Michael G. Papaioannou, and Magdalena Polan 13 A Note on Sovereign Debt Auctions: Uniform or Discriminatory? 119 Menachem Brenner, Dan Galai, and Orly Sade 14 Pension Reform and Sovereign Credit Standing 127 Alfredo Cuevas, Mar ´ ıa Gonz ´ alez, Davide Lombardo, and Arnoldo L ´ opez-Marmolejo PART III Sovereign Defaults, Restructurings, and the Resumption of Borrowing 135 15 Understanding Sovereign Default 137 Juan Carlos Hatchondo, Leonardo Martinez, and Horacio Sapriza 16 Are Sovereign Defaulters Punished?: Evidence from Foreign Direct Investment Flows 149 Michael Fuentes and Diego Saravia 17 Supersanctions and Sovereign Debt Repayment 155 Kris James Mitchener and Marc D. Weidenmier 18 Debt Restructuring Delays: Measurement and Stylized Facts 169 Christoph Trebesch 19 IMF Interventions in Sovereign Debt Restructurings 179 Javier D ´ ıaz-Cassou and Aitor Erce CONTENTS ix 20 Resuming Lending to Countries Following a Sovereign Debt Crisis 189 Luisa Zanforlin PART IV Legal and Contractual Dimensions of Restructurings and Defaults 195 21 A Code of Conduct for Sovereign Debt Restructuring: An Important Component of the International Financial Architecture? 197 Kathrin Berensmann 22 Governing Law of Sovereign Bonds and Legal Enforcement 105 Issam Hallak 23 Sovereign Debt Restructuring: The Judge, the Vultures, and Creditor Rights 211 Marcus H. Miller and Dania Thomas 24 Sovereign Debt Documentation and the Pari Passu Clause 227 Umakanth Varottil 25 Collective Action Clauses in Sovereign Bonds 235 S ¨ onke H ¨ aseler 26 Sovereignty, Legitimacy, and Creditworthiness 245 Odette Lienau 27 Odious Debts or Odious Regimes? 253 Patrick Bolton and David A. Skeel Jr. 28 Insolvency Principles: The Missing Link in the Odious Debt Debate 261 A. Mechele Dickerson PART V Historical Perspectives 267 29 The Baring Crisis and the Great Latin American Meltdown of the 1890s 269 Kris James Mitchener and Marc D. Weidenmier x Contents 30 How Government Bond Yields Reflect Wartime Events: The Case of the Nordic Market 279 Daniel Waldenstr ¨ om and Bruno S. Frey 31 How Important Are the Political Costs of Domestic Default?: Evidence from World War II Bond Markets 287 Daniel Waldenstr ¨ om 32 Emerging Market Spreads at the Turn of the Twenty-First Century: A Roller Coaster 295 Sergio Godoy PART VI Sovereign Debt in Emerging Markets 301 33 Sovereign Default Risk and Implications for Fiscal Policy 303 Gabriel Cuadra and Horacio Sapriza 34 Default Traps 309 Luis A.V. Cat˜ao, Ana Fostel, and Sandeep Kapur 35 Self-Fulfilling and Self-Enforcing Debt Crises 319 Daniel Cohen and Sebastien Villemot 36 The Impact of Economic and Political Factors on Sovereign Credit Ratings 325 Constantin Mellios and Eric Paget-Blanc 37 Sovereign Bond Spreads in the New European Union Countries 335 Ioana Alexopoulou, Irina Bunda, and Annalisa Ferrando 38 Can Sovereign Credit Ratings Promote Financial Sector Development and Capital Inflows to Emerging Markets? 345 Suk-Joong Kim and Eliza Wu 39 Country Debt Default Probabilities in Emerging Markets: Were Credit Rating Agencies Wrong? 353 Angelina Georgievska, Ljubica Georgievska, Dr. Aleksandar Stojanovic, and Dr. Natasa Todorovic CONTENTS xi 40 The International Stock Market Impact of Sovereign Debt Ratings News 361 Miguel A. Ferreira and Paulo M. Gama PART VII Sovereign Debt and Financial Crises 369 41 Equity Market Contagion and Co-Movement: Industry Level Evidence 371 Kate Phylaktis and Lichuan Xia 42 An Insolvency Procedure for Sovereign States: A Viable Instrument for Preventing and Resolving Debt Crises? 379 Kathrin Berensmann and Ang ´ elique Herzberg 43 From Banking to Sovereign Debt Crisis in Europe 387 Bertrand Candelon and Franz C. Palm 44 From Financial Crisis to Sovereign Risk 393 Carlos Caceres, Vincenzo Guzzo, and Miguel Segoviano 45 Sovereign Spreads and Perceived Risk of Default Revisited 401 Abolhassan Jalilvand and Jeannette Switzer 46 What Explains the Surge in Euro Area Sovereign Spreads During the Financial Crisis of 2007–2009? 407 Maria-Grazia Attinasi, Cristina Checherita, and Christiane Nickel 47 Euro Area Sovereign Risk During the Crisis 415 Silvia Sgherri and Edda Zoli 48 Facing the Debt Challenge of Countries That Are “Too Big To Fail” 425 Steven L. Schwarcz Index 431 [...]... debt management has meant victory or defeat in many wars Thus, sovereign debt connects with matters of great societal import—in some instances, sovereign debt determines the very survival of the state and society T 1 Sovereign Debt: From Safety to Default by Robert W Kolb Copyright © 2011 John Wiley & Sons, Inc CHAPTER 1 Sovereign Debt Theory, Defaults, and Sanctions ROBERT W KOLB Professor of Finance... Sovereign Debtors Punished? Evidence from the Gold Standard Era,” Working Paper, September 2004; “Supersanctions and Sovereign Debt Repayment,” in Robert W Kolb, ed., Sovereign Debt: From Safety to Default (Hoboken, NJ: John Wiley & Sons); and 2010, “Supersanctions and Sovereign Debt Repayment,” Journal of International Money and Finance 29, 19–36 2 Bulow and Rogoff (1989) consider an alternative to. .. terms for the sovereign to default, the total cost of default might be high enough to encourage the sovereign to avoid default and to pay as promised Default by a sovereign borrower is almost always a choice, and because the default is by a government, such a choice necessarily has a political element Recent research finds that states with certain political circumstances are more likely to default than... “Understanding sovereign default. ” In Robert W Kolb, ed Sovereign Debt: From Safety to Default, 137–147 Hoboken, NJ: John Wiley & Sons Kohlscheen, Emanuel 2010 Sovereign Risk: Constitutions Rule.” Oxford Economic Papers 62: 62–86 Lovett, A W 1980 “The Castilian Bankruptcy of 1575.” Historical Journal 23:4, 899–911 Malone, Samuel W 2011 Sovereign debt problems and policy gambles.” In Robert W Kolb, ed Sovereign. .. Constitutions, and Sovereign Borrowing in Europe, 1274–1785,” International Organization (Summer): 61, 489–525 Vizcarra, Catalina 2009 “Guano, Credible Commitments, and Sovereign Debt Repayment in Nineteenth-Century Peru.” Journal of Economic History 69:2, 358–387 Wright, Mark L J 2002 “Reputations and Sovereign Debt. ” Working Paper Sovereign Debt: From Safety to Default by Robert W Kolb Copyright ©... From Safety to Default by Robert W Kolb Copyright © 2011 John Wiley & Sons, Inc PART I The Political Economy of Sovereign Debt he chapters that comprise this section focus on the most sweeping issues of sovereign debt the role that this debt plays in the essential economy of a nation and how sovereign debt interacts with societal dimensions beyond the merely financial As the introduction has tried to. .. with imminent default, states increase the riskiness of their economic policies in an effort to “gamble for redemption”—that is, to secure sufficient funds to avoid default (Malone 2011, forthcoming) While the interaction of political factors and the propensity to default on sovereign debt remains incompletely understood, the general landscape of this interaction appears to be related to familiar issues... respect to default (Hatchondo, Martinez, and Sapriza 2007; Hatchondo, Martinez, and Sapriza 2011) CREDITOR SANCTIONS AND SOVEREIGN DEFAULTS We have already briefly considered an era in which rather extreme sanctions were enforced to collect sovereign debts Assuming that invasion and gunboat diplomacy are no longer viable, what sanctions are available to creditors to encourage sovereign borrowers to pay... During this period, it floated many bond issues for purposes ranging from debt management to financing railway construction and other wars What rescued Peru from the mire of default? As with most sovereign defaults, Peru’s problem from 1826 to 1849 was not its ability to pay, but its willingness Peru’s change from unwilling defaulter to active participant in world capital markets began with the travels... inability to pay on sovereign debt A sovereign s ability to conduct war depends on money As Cicero noted more than 2,000 years ago, “Endless money forms the sinews of war.” Had Cicero lived in our time, he might have added: “And many nations attempt to fashion these sinews from debt, ” as many nations have attempted to construct these sinews by issuing sovereign debt, and success or failure in sovereign debt . index. ISBN 97 8-0 -4 7 0-9 223 9-2 (cloth); ISBN 97 8-1 -1 1 8-0 175 3-1 (ebk); ISBN 97 8-1 -1 1 8-0 175 4-8 (ebk); ISBN 97 8-1 -1 1 8-0 175 5-5 (ebk) 1. Debts, Public. I. Kolb, Robert W., 194 9- HJ8015.S68 2011 336.3’4–dc22. Cataloging-in-Publication Data: Sovereign debt : from safety to default / Robert W. Kolb, editor. p. cm. – (Robert W. Kolb series in finance) Includes bibliographical references and index. ISBN 97 8-0 -4 7 0-9 223 9-2 . finance. Please visit www.wiley.com/go/kolbseries to learn about recent and forthcoming titles in the Kolb Series. SOVEREIGN DEBT From Safety to Default Robert W. Kolb The Robert W. Kolb Series in Finance John