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The Costs of Sovereign Defaults:Theory and Empirical Evidence

  • Guido Sandleris

A sovereign default is sometimes perceived by economic policy makers as a jump into the unkown. The main piece of information missing is what the costs of a sovereign default are going to be and how they arise. Knowing this is crucial when trying to evaluate how far a country should go to avoid a default. This paper analyzes the theoretical and empirical evidence on the costs of sovereign defaults. It classi…es the costs of defaults in three categories: (1) Costs imposed as penalties by creditors; (2) Costs related to the information content of defaults; (3) Costs related to domestic agents�sovereign bond holdings. A simple model that captures the main intuitions behind each of these costs is presented. The paper also reviews the empirical evidence on the costs of sovereign defaults. Contrary to the conventional wisdom that seems to believe that the main costs of defaults are related to the exclusion of the sovereign from credit markets or higher subsequent borrowing costs for the sovereign, this paper argues that, under the light of the existing evidence, the main costs of defaults are related to their negative effects on credit both foreign and domestic to the domestic private sector and trade. These e�ects do not seem to be caused by penalties imposed by creditors. They seem to be the result mainly of the effect of defaults on domestic agents�balance sheets and expectations.

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Paper provided by Universidad Torcuato Di Tella in its series Business School Working Papers with number 2012-02.

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Length: 32 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:udt:wpbsdt:2012-02
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  9. R. Gaston Gelos, Ratna Sahay and Guido Sandleris, 2008. "Sovereign Borrowing by Developing Countries: What Determines Market Access?," Business School Working Papers 2008-02, Universidad Torcuato Di Tella.
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  14. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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  21. Flandreau, Marc & Sussman, Nathan, 2004. "Old Sins: Exchange Rate Clauses and European Foreign Lending in the 19th Century," CEPR Discussion Papers 4248, C.E.P.R. Discussion Papers.
  22. 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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  24. Peter H. Lindert & Peter J. Morton, 1989. "How Sovereign Debt Has Worked," NBER Chapters, in: Developing Country Debt and Economic Performance, Volume 1: The International Financial System, pages 39-106 National Bureau of Economic Research, Inc.
  25. Martinez, Jose Vicente & Sandleris, Guido, 2011. "Is it punishment? Sovereign defaults and the decline in trade," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 909-930, October.
  26. Eugenia Andreasen & Guido Sandleris & Alejandro Van Der Ghote, 2011. "The Political Economy of Sovereign Defaults," Business School Working Papers 2011-07, Universidad Torcuato Di Tella.
  27. Ozler, Sule, 1993. "Have Commercial Banks Ignored History?," American Economic Review, American Economic Association, vol. 83(3), pages 608-20, June.
  28. Mauro Alessandro & Guido Sandleris & Alejandro Van Der Ghote, 2011. "Sovereign Defaults and The Political Economy Of Market Reaccess," Business School Working Papers 2011-08, Universidad Torcuato Di Tella.
  29. Peter Benczur & Cosmin Ilut, 2011. "Evidence for Dynamic Contracts in Sovereign Bank Lending," Working Papers 11-06, Duke University, Department of Economics.
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