Discussion Paper Details

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Title: Why Do Emerging Economies Borrow Short Term?

Author(s): Fernando A Broner, Guido Lorenzoni and Sergio Schmukler

Publication Date: April 2007

Keyword(s): emerging market debt, financial crises, investor risk aversion, maturity structure, risk premium and term premium

Programme Area(s): International Macroeconomics

Abstract: We argue that emerging economies borrow short term due to the high risk premium charged by bondholders on long-term debt. First, we present a model where the debt maturity structure is the outcome of a risk sharing problem between the government and bondholders. By issuing long-term debt, the government lowers the probability of a rollover crisis, transferring risk to bondholders. In equilibrium, this risk is reflected in a higher risk premium and borrowing cost. Therefore, the government faces a trade-off between safer long-term debt and cheaper short-term debt. Second, we construct a new database of sovereign bond prices and issuance. We show that emerging economies pay a positive term premium (a higher risk premium on long-term bonds than on short-term bonds). During crises, the term premium increases, with issuance shifting towards shorter maturities. The evidence suggests that international investors' time-varying risk aversion is crucial to understand the debt structure in emerging economies.

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Bibliographic Reference

Broner, F, Lorenzoni, G and Schmukler, S. 2007. 'Why Do Emerging Economies Borrow Short Term?'. London, Centre for Economic Policy Research.