Restructuring the Sovereign Debt Restructuring Mechanism

Sovereign defaults are time consuming and costly to resolve ex post. But these costs also improve borrowing incentives ex ante. What is the optimal tradeoff between efficient borrowing ex ante and the costs of default ex post? What policy reforms, from collective action clauses to an international bankruptcy court, would attain this optimal tradeoff? Towards an answer to these questions, this paper presents a simple incomplete markets model of sovereign borrowing that is coupled with an explicit and flexible model of the sovereign debt restructuring process. We characterize the optimal amount of delay, and explore numerically the effects of various policy options on the amount of delay in renegotiations, and on the efficiency of capital flows.