Cash debt buybacksand the insurance value of reserves
van Wijnbergen, Sweder
Bulow and Rogoff showed in 1988 that auction based purchases of debt could not be an effective way to capture the secondary market discount, since the purchase pushes up the secondary market afterward. The author of this report points out another problem with cash debt buy backs - one that arises because terms of trade contingent instruments do not exist in international capital markets, and because of the differences in risk aversion that one may plausibly assume to exist between commercial creditors and the developing countries that are their debtor clients. Under such circumstances, secondary market prices fail to reflect the insurance value reserves have to debtors but not to creditors - since, after all, the secondary market reflects mostly intrabank transactions. As a result, the country buying back debt with reserves clearly ends up worse off, even if it succeeds in capturing the full secondary market discount prevailing before the buyback - because the buyback reduces the insurance possibilities open to the country.
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