Sovereign Debt Maturity Structure and Dilution

Abstract

The maturity structure of debt plays an important role in default probability and the resulting pricing of sovereign bonds. Using a calibrated model this paper shows that both the default probabilities and the prices get improved when the sovereign issues long-term bonds or both short- and long-term bonds instead of issuing only short-term bonds. This paper also shows that the inclusion of the compensation covenant mitigates the dilution problem of sovereign debt on a larger scale when the maturity of long-term bonds is sufficiently high.