Working Paper no. 184
By Benjamin Martin and Adrian Penalver
Payments standstills have been suggested as a tool for the resolution of financial crises in emerging markets economies. A simple model is developed here to examine the implications of standstills for yields and the maturity structure of debt. An emerging market country chooses to sell short and long-term debt to risk-neutral international investors. The key assumptions are that the level of short-term debt increases the probability of crisis, that crises have costs that spill over into the next period, and that the orderly resolution of financial crises will reduce the cost of crises. A standstill is depicted as an orderly rollover of short-term debt. Standstills have the benefit of reducing the proportion of short-term debt and so lower the probability of crisis. This comes at the cost of generally lower expected output.