IMF Working Papers

Default Premium

By Luis Catão, Rui Mano

July 21, 2015

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Luis Catão, and Rui Mano. Default Premium, (USA: International Monetary Fund, 2015) accessed November 21, 2024
Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

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.

Subject: Asset and liability management, Credit, Debt default, Debt settlement, Emerging and frontier financial markets, External debt, Financial markets, Money, Public debt

Keywords: Country Risk, Credit, Debt default, Debt settlement, Default premium, Default premium variable, DP estimate, Emerging and frontier financial markets, Emerging Markets, Exclusion spell, Global, Haircut, Interest rate, Interest Rate Spread, Market access, Market exclusion, Market re-entry, Repayment decision, Settlement dummy, Sovereign Debt, WP

Publication Details

  • Pages:

    57

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2015/167

  • Stock No:

    WPIEA2015167

  • ISBN:

    9781513523507

  • ISSN:

    1018-5941

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