Stefano Neri

Luca Dedola

What Does a Techology Shock Do? A VAR Analysis with Model-based Sign Restrictions

What Does a Technology Shock Do? A VAR Analysis with Model-based Restrictions

A VAR Analysis with Model-based Sign Restrictions

What Does a Technology Shock Do?

Giancarlo Corsetti

Mr.Anil Ari

Is the seniority structure of sovereign debt neutral for a government's decision between defaulting and raising surpluses? In this paper, we address this question using a model of debt crises where a discretionary government endogenously chooses distortionary taxation and whether to apply an optimal haircut to bondholders. We show that when the size of senior tranches is small, a version of the Modigliani-Miller theorem holds: tranching just redistributes government revenues from junior to senior bondholders, while taxes and government borrowing costs remain unchanged. However, as senior tranches become sufficiently large, default costs on senior debt transpire into a stronger commitment to repay not only the senior tranche, but also the junior one. We show that there is a lower threshold for senior bonds above which tranching can eliminate default on both junior and senior debt, and an upper threshold beyond which the government defaults also on senior debt.

Luca Dedola

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