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Default premium

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  • Catão, Luis A.V.
  • Mano, Rui C.

Abstract

The literature has found that sovereigns with a history of default are charged only a small and/or short-lived premium on the interest rate warranted by observable fundamentals. We re-assess this view using a metric of such a “default premium” (DP) that nests previous metrics and applying it to a much broader dataset. We find a sizeable and persistent DP: in 1870–1938, it averaged 250bps upon market re-entry, tapering to around 150bps five years out; in 1970–2014 the respective estimates are about 350 and 200bps. We also find that: (i) the DP accounts for between 30 and 60% of the sovereign spread within five years of market re-entry, and its contribution to the spread remains non-negligible thereafter; (ii) The DP is higher for countries that take longer to settle with creditors and is on average higher for serial defaulters; (iii) our estimates are robust to many controls including realized “haircuts”. These findings help reconnect theory and evidence on why sovereigns default only infrequently and, when they do, why earlier debt settlements are typically sought.

Suggested Citation

  • Catão, Luis A.V. & Mano, Rui C., 2017. "Default premium," Journal of International Economics, Elsevier, vol. 107(C), pages 91-110.
  • Handle: RePEc:eee:inecon:v:107:y:2017:i:c:p:91-110
    DOI: 10.1016/j.jinteco.2017.03.005
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    More about this item

    Keywords

    Sovereign debt; Country risk; Interest rate spread; Haircut; Emerging markets;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • N20 - Economic History - - Financial Markets and Institutions - - - General, International, or Comparative

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