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The Costs of (sub)Sovereign Default Risk: Evidence from Puerto Rico

Anusha Chari (), Ryan Leary and Toan Phan ()

No 18-3, Working Paper from Federal Reserve Bank of Richmond

Abstract: Puerto Rico's unique characteristics as a U.S. territory allow us to examine the channels through which (sub)sovereign default risk can have real effects on the macroeconomy. Post-2012, during the period of increased default probabilities, the cointegrating relationship between real activity in Puerto Rico and the U.S. mainland breaks down and Puerto Rico spirals into a significant decline. We exploit the cross-industry variation in default risk exposure to identify the impact of changes in default risk on employment. The evidence suggests that there are significantly higher employment growth declines in government demand and external finance dependent industries. An additional real effect of default anticipation is that heightened default risk Granger causes Puerto Rico's austerity measures. An event study analysis using government bond yields and stock returns confirms that news of increased default risk increases the cost of capital for the Puerto Rican government and for publicly traded Puerto Rican firms.

Keywords: Sovereign debt; default risk; growth; employment; cost of capital; external finance dependence; government demand (search for similar items in EconPapers)
JEL-codes: F3 F4 G15 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2018-02-17
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