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Sovereign default and macroeconomic tipping points

Author

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  • Joy, Mark

    (Central Bank of Ireland)

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.

Suggested Citation

  • Joy, Mark, 2012. "Sovereign default and macroeconomic tipping points," Research Technical Papers 10/RT/12, Central Bank of Ireland.
  • Handle: RePEc:cbi:wpaper:10/rt/12
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Sovereign default; risk; model uncertainty;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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