More speci^cally, the creditor (the bank) wants to solve two distinct problems
at the same time: the ...rst one is the “moral hazard” problem, which directly
derives from the “debt overhang”, that is the lack of incentives to invest for the
“good type” in the absence of any debt relief. The second problem is the need for
the bank to separate between the two types in order not to grant the relief to the
“bad” one (that is the one which will never invest).
Notice that, in the theoretical model, our de.nition of debt relief involved
more a debt reduction rather than a debt rescheduling. We believe that a debt
rescheduling can be considered as a component of a debt relief initiative (in par-
ticular when it is made at concessional terms, as it is the case for low-income
countries). However, di∏erently to the aforementioned empirical papers, where it
was seen generally as an indicator of a country’s debt servicing d^culties, here
debt rescheduling is considered mainly as a debt relief which creditors may either
decide to grant or not.
In order to .nd the “qualitative factors” which can in≠uence the probability
ofa debt rescheduling, for simplicity, we will focus here only on the .rst problem,
that is on the “moral hazard” aspect.11 Thus, the main idea is to.nd the factors
which a∏ect the amount of debt relief creditors need to grant in order to make
the good type invest and repay. The “moral hazard” condition, which makes the
good type country willing to invest (and repay), is that the bene.ts from the
investment are greater than its costs. After some rearrangements that becomes:
R . D i V (m i 1)=(1 i qκ) i ®(Q(2) + bS): (3.1)
In equation (3.1) R represents the amount of the debt relief and D stands for
the total amount of external debt and it is positively correlated with R. V (m i
1)=(1 i qH) corresponds to the outcome of the investment, (m i 1)V; divided by
11If we solved the model taking into account both the “participation” and “the self selection”
constraint we would .nd that basically the same factors will a°ect the probability of a debt
reschedu li n g. For more details on t his, see the quoted paper.
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