Three Sisters: The Interlinkage between Sovereign Debt, Currency and Banking Crises

The sovereign debt default and the linkages from banking and currency crisis have been rarely explored in the crisis literature. This study attempts to dive into this unexplored area by applying panel data binary choice model on a sample with 20 emerging countries having monthly observations for the years between 1985 and 2007. The non-linear linkages from currency and banking crises to sovereign defaults are explored by using the interactions of these crises with international illiquidity, appreciated real exchange rates and real international monetary policy rates. It is discovered that currency, banking and debt crises tend to occur simultaneously. Prior occurrence of a currency crisis increases the sovereign default probability through appreciated real exchange rates, and in countries with high short-term indebtedness the occurrence of banking crisis raises the probability of a debt crisis.