Renegotiation in Debt Chains

Vincent Glode, Christian Opp

NBER Working Paper No. 27883
Issued in October 2020
NBER Program(s):Asset Pricing, Corporate Finance, International Finance and Macroeconomics, Monetary Economics

We develop a tractable model of strategic debt renegotiation in which businesses are sequentially interconnected through their liabilities. This financing structure, which we refer to as a debt chain, gives rise to externalities as a lender’s willingness to provide concessions to his privately-informed borrower depends on how this lender’s own liabilities are expected to be renegotiated. Our analysis reveals how targeted government subsidies and debt reductions as well as incentives for early renegotiation following large economic shocks such as COVID-19 or a financial crisis can prevent default waves.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w27883