TAILIEUCHUNG - Default and the Maturity Structure in Sovereign Bonds∗

This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. In the data, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large long-term loans are not available because theborrowercannotcommittosaveinthenearfuturetowardsrepaymentinthefarfuture. However, issuing long-term debt can insure against the need to roll-over short-term debt at high interest rate spreads. The trade-off between these two benefits is quantitatively important. | Default and the Maturity Structure in Sovereign Bonds Cristina Arellano Ananth Ramanarayanan University of Minnesota and Federal Reserve Bank of Dallas Federal Reserve Bank of Minneapolis November 2008 Abstract This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. In the data when interest rate spreads rise debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt large long-term loans are not available because the borrower cannot commit to save in the near future towards repayment in the far future. However issuing long-term debt can insure against the need to roll-over short-term debt at high interest rate spreads. The trade-off between these two benefits is quantitatively important for understanding the maturity composition in emerging markets. When calibrated to data from Brazil the model matches the dynamics in the maturity of debt issuances and its comovement with the level of spreads across maturities. We thank V. V. Chari Tim Kehoe Patrick Kehoe Narayana Kocherlakota Hanno Lustig Enrique Mendoza Fabrizio Perri and Victor Rios-Rull for many useful comments. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis the Federal Reserve Bank of Dallas or the Federal Reserve System. All errors remain our own. Í arellano@ . 1 Introduction Emerging markets face recurrent and costly financial crises that are characterized by limited access to credit and high interest rates on foreign debt. As crises approach not only is debt limited but also the maturity of debt shortens as documented by Broner Lorenzoni and Schmukler 2007 .1 During these

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