Default Premium

Luis Catão () and Rui Mano

No 2015/167, IMF Working Papers from International Monetary Fund

Abstract: We re-assess the view that sovereigns with a history of default are charged only a small and/or short-lived premium on the interest rate warranted by observed fundamentals. Our reassessment uses a metric of such a “default premium” (DP) that is consistent with asymmetric information models and nests previous metrics, and applies it to a much broader dataset relative to earlier studies. We find a sizeable and persistent DP: in 1870-1938, it averaged 250 bps upon market re-entry, tapering to around 150 bps five years out; in 1970- 2011 the respective estimates are about 400 and 200 bps. We also find that: (i) these estimates are robust to many controls including on actual haircuts; (ii) the DP accounts for as much as 60% of the sovereign spread within five years of market re-entry; (iii) the DP rises with market exclusion spells. These findings help reconnect theory and evidence on why sovereign defaults are infrequent and earlier debt settlements are desirable.

Keywords: WP; default premium; interest rate; Sovereign Debt; Country Risk; Interest Rate Spread; Haircut; Emerging Markets; market re-entry; settlement dummy; repayment decision; market exclusion; DP estimate; default premium variable; market access; exclusion spell; Debt settlement; Credit; Emerging and frontier financial markets; Debt default; Global (search for similar items in EconPapers)
Pages: 57
Date: 2015-07-21
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Citations: View citations in EconPapers (3)

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