Market Reactions to Sovereign Litigation

Faisal Z. Ahmed; Laura  Alfaro

Article | Capital Markets Law Journal

Market Reactions to Sovereign Litigation

by Faisal Z. Ahmed and Laura Alfaro

Abstract

Recent rulings in the ongoing litigation over the pari passu clause in Argentinian sovereign debt instruments have generated considerable controversy. Some official-sector participants and academic articles have suggested that the rulings will disrupt or impede future sovereign debt restructurings by encouraging holdout creditors to litigate for full payment instead of participating in negotiated exchange offers. This paper critically examines this claim by evaluating market reactions to litigation using an event study methodology. We analyze the effect on sovereign bonds from litigation events, with particular emphasis on Argentina for the period, 1993-2014. We find evidence that the market reacts differently to Argentina than in other countries.

Keywords: Sovereign debt; litigation; vulture funds; Argentina; Sovereign Finance; Lawsuits and Litigation; Markets; Argentina;

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Ahmed, Faisal Z., and Laura Alfaro. "Market Reactions to Sovereign Litigation." Capital Markets Law Journal 12, no. 2 (April 2017): 141–163.

For the past few decades, Australia has dealt with the benefits and costs of repeated mining booms—inflation, a housing bubble, a current account deficit, and growing dependence on China. Between 1996 and 2007, however, Australia had most of these issues under control and grew at impressive rates, becoming one of the richest of developed countries. Yet competitiveness in its non-mining sectors declined. Since the financial crisis, additional challenges associated with climate change, minerals taxes, migration, fiscal deficits, and currency fluctuations have complicated the issues facing both Labor and Liberal administrations, with a very thin majority. Meanwhile, Australia's non-mineral competitiveness continues to recede.

Case | HBS Case Collection | July 2005 (Revised September 2020)

The U.S. Current Account Deficit

Laura Alfaro, Rafael Di Tella, Ingrid Vogel, Renee Kim, Sarah Jeong, Matthew Johnson and Jonathan Schlefer

Investors and policymakers throughout the world were confronted with the risk of painful economic consequences arising from the large U.S. current account deficit. In 2007, the U.S. current account deficit was $731 billion, equivalent to 5.3% of GDP. The implications of the deficit were debated with intensity. At one extreme, it was argued that large deficits would eventually resolve themselves smoothly, even if they persisted for many more years. Former Federal Reserve Chairman Alan Greenspan was among those expecting a "benign resolution to the U.S. current account imbalance." Other analysts, such as economists at the World Bank, believed the large deficits raised the risk of a sharp and disorderly fall of the dollar and that necessary macroeconomic adjustment could be painful, for the United States as well as for the rest of the world. The Financial Times asked: "How long will foreigners be prepared to make such generous 'gifts' to the US?" In this environment, Berkshire Hathaway, run by legendary investor Warren Buffett, postulated that current account imbalances would lead to "some chaotic markets in which currency adjustments play a part" and announced to shareholders a plan to increase investment in overseas companies to protect against this risk. It remained to be seen what the short- and long-term implications of the current account deficit would ultimately yield.

Keywords: world economy; Macroeconomics; Borrowing and Debt; Currency; Foreign Direct Investment; Business and Government Relations; United States;

Citation:

Alfaro, Laura, Rafael Di Tella, Ingrid Vogel, Renee Kim, Sarah Jeong, Matthew Johnson, and Jonathan Schlefer. "The U.S. Current Account Deficit." Harvard Business School Case 706-002, July 2005. (Revised September 2020.) View Details

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In the past decade, foreign participation in local-currency bond markets in emerging countries increased dramatically. Additionally, emerging countries are increasingly deviating from inflation targeting regimes, managing their exchange rate and engaging in exchange-rate accumulation. In light of these trends, we revisit sovereign debt sustainability, and the choice of the optimal exchange-rate regime, under the assumptions that countries can accumulate reserves and borrow internationally using their own currency. As opposed to traditional sovereign debt models, asset valuation effects occasioned by currency fluctuations act to absorb global shock and render consumption smoother. Countries do not accumulate reserve to be depleted in “bad” times. Instead, issuing domestic debt while accumulating reserves acts as a hedge against external shocks. We propose that a “pseudo-flexible regime” is the best policy alternative for emerging nations that face international shocks. A quantitative exercise suggests this strategy to be effective for smoothing consumption and reducing the occurrence of default and obtains that optimal reserve holdings turn out to be as large as those presently observed.

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Market Reactions to Sovereign Litigation

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