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Sovereigns going bust: Estimating the cost of default

Dmitry Kuvshinov and Kaspar Zimmermann

European Economic Review, 2019, vol. 119, issue C, 1-21

Abstract: What is the cost of sovereign default, and what makes default costly? This paper uses a novel econometric method – combining local projections and propensity score weighting as in Jordà and Taylor (2016) – to study these questions. We find that default generates a long-lasting output cost – 2.7% of GDP on impact and 3.7% at peak after five years – but in the longer term, economic activity recovers. The downturn is characterised by a collapse in investment and gross trade. The cost rises dramatically if the default is followed by a systemic banking crisis – peaking at some 9.5% of GDP – but is attenuated for economies with floating exchange rates. Our findings suggest that financial autarky, trade frictions and sovereign-banking spillovers play a key role in generating the cost of default.

Keywords: Sovereign default; Sovereign debt; Banking crises; Local projections; Inverse propensity score weighting (search for similar items in EconPapers)
JEL-codes: H63 F34 F41 G01 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1016/j.euroecorev.2019.04.009

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