Efficient Sovereign Debt Buybacks

This paper challenges the conventional view that debt buybacks are detrimental to sovereign borrowers. Using a model of strategic lending, I show that buybacks can be rationalized as part of an optimal contract between a sovereign borrower and foreign lenders. In particular, buybacks allow bonds to function like Arrow securities. This is because they take place in the secondary market, where only legacy lenders operate, granting them market power, as opposed to the primary market, where new entrants ensure competitive returns. This mechanism can substitute for or complement standard implementations based on debt restructurings. The model is supported by recent empirical evidence from Brazil, where the buyback premium can be attributed to both limited secondary market competition and reduced default risk. These findings offer insights into sovereign debt management and the implementation of optimal contra