6.3 Beliefs A DSA requires a definition of the distribution of shocks. 7 From the viewpoint of analysts and market participants, those distributions are subjective: no one knows(even if someone pretends to) the true probability density functions of the variables that determine debt sustainability; in other words, we do not live in a world of rational expectations. The market risk premium reflects market expectations, which includes heterogenous expectations of many participants, but even when market participants’ expectations are correct on average, there is no simple relationship between the observed market price and the true risk of default. Indeed, it appears that on average market participants in a diversified portfolio of sovereign bonds would have received a high(beta-adjusted) return over the last two centuries(Meyer, Reinhart, and Trebesch, 2022). This is especially problematic given that the most optimistic are the“marginal buyers” of the bonds(Geanakoplos, 2010). It thus appears that rational investors buying sovereign bonds are more than adequately compensated for the risks borne. The definition of the distribution of shocks is also associated with discrepancies in debt negotiations. Under incomplete contracts, and for the same reasons discussed in relation to preserving the possibility of higher payments in the upside scenarios, creditors will tend to be more optimistic than the debtor about the baseline scenario. Recent restructurings(for example, Suriname, Sri Lanka, and Zambia) are including contingent clauses in the restructured bonds. While contingent debt such as GDP-linked bonds is supposed to improve debt sustainability, by aligning scheduled debt payments with payment capacity, the model that is emerging in those restructurings is not moving in that direction: Instead, the contingent clauses are asymmetric, implying that in the case of upside scenarios creditors get the benefits, but in the case of downside scenarios payments are not lowered(or not lowered symmetrically, as in Sri Lanka), even though the bonds’ coupons include a significant risk-premium. 7. Who performs DSAs? Sovereigns in debt distress rarely perform DSAs. They rely on the DSA conducted by the IMF or at times also on the work of external advisors, such as the international investments banks that sell sovereign advisory services. This reliance on external actors often means that the interests of the citizens of the country in distress are not adequately represented in the frameworks for debt negotiations, as the incentives of other stakeholders or external advisors are generally different from those of the sovereign whose debt is being restructured. As we have already noted, incentives matter when it comes to some of the critical assumptions in doing a DSA. Most governments of developing countries do not even have the capacity to do a DSA. Their debt management offices do not develop those institutional capabilities and hiring staff capable of performing these analyses may prove impossible given the discrepancies between salaries offered by governments and those available in the private sector or at international financial institutions. In the very few cases in which a government produces a DSA, creditors have incentives to de-legitimize it. Even if the analysis is sound, creditors generally claim that the government’s position is biased, and that it is not acting in good faith. They often have the available resources to succeed in such campaigns. Private or bilateral creditors do not follow the practice of publishing DSAs, either at the time the loan is made or when it may have to be restructured. If they did, their views at the time of providing financing – including the foreseen circumstances that justified the risk premium – would be clearer. China did publish a“Debt Sustainability Framework for Participating Countries of the Belt and Road Initiative”(Ministry of Finance of 7 This is only part of the disagreement in probability distribution of outcomes, which is what matters for bonds trading. Series: Debt Sustainability Assessments& Their Role in the International Financial Architecture 7