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Juan Carlos Hatchondo, Mr. Leonardo Martinez, Kursat Onder, and Mr. Francisco Roch
We study a model of equilibrium sovereign default in which the government issues cocos (contingent convertible bonds) that stipulate a suspension of debt payments when the government faces liquidity shocks in the form of an increase of the bondholders' risk aversion. We find that in spite of reducing the frequency of defaults triggered by liquidity shocks, introducing cocos increases the overall default frequency. By mitigating concerns about liquidity, cocos make indebtedness and default risk more attractive for the government. In contrast, cocos that stipulate debt forgiveness when the government faces the shock, achieve larger welfare gains by reducing default risk.
Juan Carlos Hatchondo, Mr. Leonardo Martinez, Kursat Onder, and Mr. Francisco Roch

, 2013 , iscussion ( 2014 ). One argument against cocos is that if the triggering of maturity-extending clauses becomes more likely, creditors would scramble out of the market, triggering a liquidity crisis. This paper presents a formal quantitative analysis of sovereign cocos. Would cocos reduce or increase the frequency of crises and the sovereign spreads paid by the government? Would they benefit the government? Should the reprofiling mandated by cocos be accompanied by face-value haircuts? We measure the effects of cocos using a quantitative sovereign default

Juan Carlos Hatchondo, Mr. Leonardo Martinez, Kursat Onder, and Mr. Francisco Roch

Copyright Page © 2022 International Monetary Fund WP/22/78 IMF Working Paper Research Department Sovereign Cocos Prepared by Juan Carlos Hatchondo, Leonardo Martinez, Kursat Onder and Francisco Roch * Authorized for distribution by Prachi Mishra April 2022 IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate . The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management

Juan Carlos Hatchondo, Mr. Leonardo Martinez, and Cesar Sosa Padilla

sovereign default models: solution methods matter ,” Review of Economic Dynamics , 2010 , 13 ( 4 ), 919 – 933 . Hatchondo , Juan Carlos , Yasin Kürşat , Önder , and Francisco Roch , “ Sovereign cocos ,” 2020 . Manuscript. IMF , “ State-Contingent Debt Instruments for Sovereigns ,” 2017 . IMF Policy Paper . International Monetary Fund . IMF , “ State-Contingent Debt Instruments for Sovereigns—Annexes ,” 2017 . IMF Policy Paper . International Monetary Fund . IMF , “ A Cautious Reopening ,” 2020 . Sub-Saharan Africa Regional

Juan Carlos Hatchondo, Mr. Leonardo Martinez, and Cesar Sosa Padilla
As a response to economic crises triggered by COVID-19, sovereign debt standstill proposals emphasize debt payment suspensions without haircuts on the face value of debt obligations. We quantify the effects of standstills using a standard default model. We find that a one-year standstill generates welfare gains for the sovereign equivalent to a permanent consumption increase of between 0.1% and 0.3%, depending on the initial shock. However, except when it avoids a default, the standstill also implies capital losses for creditors of between 9% and 27%, which is consistent with their reluctance to participate in these operations and indicates that this reluctance would persist even without a free-riding or holdout problem. Standstills also generate a form of “debt overhang” and thus the opportunity for a “voluntary debt exchange”: complementing the standstill with haircuts could reduce creditors’ losses and simultaneously increase welfare gains. Our results cast doubts on the emphasis on standstills without haircuts.