Renegotiations on Sovereign Debt: Reduce or Reschedule?∗

We present a continuous time model of sovereign debt with the possibility to renegotiate once the terms of the contract. Renegotiations consist of a debt reduction or a debt rescheduling. The model provides closed-form solutions for debt values with endogenous default policy and renegotiations terms. Simulations indicate that both reduction and rescheduling deals allow the lender and the sovereign to move away from the wrong side of the debt Laffer curve well before the sovereign is highly indebted. The model also allows for a direct comparison of the benefits of debt reduction and debt rescheduling schemes. In most cases debt reduction deals appear most efficient in lowering sovereign default risk, thereby validating the historical move from the Baker plan to the Brady plan. However, debt rescheduling deals imply higher sovereign debt value in two cases: (i) when sovereign exports are very volatile, and (ii) when debt recovery value is particularly high. The model therefore advocates for a case by case approach since debt reductions may not always be the most value enhancing deals in sovereign lending. JEL Classification: F34, G13.