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Sovereign default and macroeconomic tipping points

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  • Joy, Mark

    (Central Bank of Ireland)

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Abstract

This paper examines the impact of macroeconomic fundamentals on the probability of sovereign default and the probability of exit from default while allowing explicitly for model uncertainty. Model uncertainty is addressed by employing Bayesian model-averaging techniques, averaging over a very large number of different empirical models that each endeavour to explain entry to and exit from periods of sovereign default for defaulting countries over the period 1975 to 2010. Default probabilities are estimated and then used to price sovereign bond spreads. Key findings are: (i) large budget deficits and high interest payments on external debt represent key macroeconomic tipping points for sovereign default; (ii) for exiting periods of default, reducing public debt matters most. These results are robust to both narrow and wide definitions of sovereign default and, due to use of model-averaging techniques, robust to model uncertainty.

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Bibliographic Info

Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 10/RT/12.

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Date of creation: Sep 2012
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Handle: RePEc:cbi:wpaper:10/rt/12

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Keywords: Sovereign default; risk; model uncertainty;

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References

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  3. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-97, December.
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