DP6249 Why Do Emerging Economies Borrow Short Term?

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

Publication Date: April 2007

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

JEL(s): E43 , F30 , F32 , F34 , F36 , G15

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6249.asp.asp

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.