Debt relief

This paper develops pricing formulae for sovereign debt by incorporating strategic debt relief games into a model of debt pricing under continuous time uncertainty. Two types of debt relief for sovereign borrowers are considered: debt reductions and exit deals. The formulae provide a good fit to the data and generate plausible predictions in a simulation analysis. The paper also examines how the availability of credible commitment mechanisms affects the amount of debt reduction. Compared with the time-consistent equilibrium, creditors would want to commit to a larger, later debt reduction while the debtor would rather have an earlier, smaller debt reduction. (C) 2000 Elsevier Science B.V. All rights reserved.