Optimal Sovereign Debt Structure: Evidence and Theory

Department: Finance

Speaker: Josef Zechner (WU Vienna) 

Room: T004

Optimal Sovereign Debt Structure: Evidence and Theory

Abstract

We document that emerging market sovereigns have increased leverage while shifting
toward local-currency borrowing, alongside a pronounced shortening of maturities.
In contrast, advanced economies exhibit neither trend and fund almost exclusively
in local currency. We rationalize these patterns with a model in which a sovereign
without commitment jointly chooses debt currency and maturity, trading off inflation
distortions, rollover risk, and currency mismatch. Higher local-currency leverage,
weaker institutions, and greater foreign participation in local-currency markets tilt
sovereigns toward shorter maturities, heightening exposure to rollover crises. When
commitment frictions are severe, sovereigns rely on foreign-currency debt instead.
Using novel granular bond-level data and plausibly exogenous capital flow shocks,
we find strong empirical support.