Work in Progress

Tying Yourself to the Mast: Painful Debt as a Commitment Device in Self-Fulfilling Debt Crises

Runner-up of the Cambridge Finance Best Student Paper award 2024

Draft available upon request here

Abstract. This paper studies why countries end up at a disadvantageous point of high debt and high economic cost of default. I propose that in normal times, governments may figuratively "tie themselves to the mast" by shifting to a debt portfolio that is more painful to restructure. This commits governments to repay and momentarily allows them to sustain higher debt levels, but makes the sovereign more vulnerable to large economic shocks. Empirically, I find support for this commitment channel by exploiting variation in high-frequency financial data around a series of sovereign debt litigation outcomes: a one ppt increase in creditors' expected recovery rate reduces markets' beliefs about the likelihood of a default event by 0.46 ppt. I further develop these results in a debt crisis framework in which a government can issue two bonds that differ in how painful they are to restructure. I find that governments indeed optimally shift towards more painful debt portfolios to momentarily rule out liquidity crises and increase debt levels.

Working Papers

Abstract. The COVID-19 pandemic has caused the most universal health and socio-economic crisis in recent history. However, the magnitude of the economic damage has differed widely; some countries were hit particularly hard, while others have managed to weather the storm much better. In this paper, we use cross-country regression analysis to identify factors that help explain the differences in the growth impact of the COVID-19 shock. Our findings underscore the critical role of balancing health and economic concerns in managing the pandemic as both a country’s exposure to the coronavirus and the stringency of containment measures are strongly correlated with its growth performance. In addition, our results shed light on several aspects of economic resilience. Good governance, provision of fiscal support and strong macroeconomic fundamentals all helped cushion the economic impact. By contrast, a lack of economic diversification – reflected in overreliance on the tourism sector or oil production – has significantly amplified the shock.

UN DESA Policy Paper