This paper explores the reasons why sovereign borrowers post collateral. Such
behavior is paradoxical because conventional interpretations of collateral stress
repossession of the assets pledged as the key to securing lenders against information
asymmetries and moral hazard. However, repossession is generally difficult in the case
of sovereign debt and in some cases impossible. Nevertheless, such sovereign
“hypothecations” have a long history and are again becoming very popular today in
developing countries. To explain sovereign collateralization, we emphasize an
informational channel. Posting collateral produces information on opaque borrowers by
displaying borrowers’ behavior and resources. We support this interpretation by
examining the hypothecation “mania” of 1849-1875, when sovereigns borrowing in the
London Stock Exchange pledged all kinds of intangible revenues. Yet, at that time,
sovereign immunity fully protected both sovereigns and their assets and possessions.
Still, we show that hypothecations significantly decreased the cost of sovereign debt.
To explain how, we stress the pledges’ role in documenting sovereigns’ wealth and the
management of revenue streams. Based on an exhaustive library of bond prospectuses
collected from primary sources, matched with a panel of sovereign bond yields and an
innovative measure of sovereign fiscal transparency, we show that collateral minutely
described in debt covenants served to document and monitor sovereign resources and
development prospects. Encasing this information in contracts written by lawyers served
to certify the quality of the resulting data disclosure process, explaining investors’
readiness to pay a premium.
The Cost of Consumer Collateral: Evidence from Bunching