Partial Default

This paper studies official sovereign debt empirically and theoretically. Official sovereign debt is more than half of the total sovereign debt in emerging markets and tends to flow in during default episodes. We develop a model with official and private debt where the sovereign can partially default on each of its debts. A fraction of the defaulted debt accumulates during a default episode, which resolves when the sovereign pays back its accrued obligations. Official debt is longer-term and more concessional during defaults than private debt, and the prices of all debts compensate lenders for default losses. The contractual differences across debts allow our model to rationalize the stylized facts of emerging markets. Counterfactual analysis suggests that official debt is welfare improving and finds the feasibility of voluntary swaps that generate Pareto Improvements by exchanging one type of debt for another one. Our work rationalizes the involvement of official debt in the resolution of sovereign defaults.