DP13084 (At Least) Four Theories for Sovereign Default

Author(s): Markus Eberhardt
Publication Date: July 2018
Keyword(s): early warning system, International Capital Markets, Politics, public debt, punishment, reputation, sovereign default, Spillovers
JEL(s): F34, F41, G15, H63
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13084

Why do some sovereigns repay their debts while others default? I empirically study four theories for default (or its avoidance): (i) reputation, (ii) punishment, (iii) domestic politics, and (iv) international spillovers. Running horse races for a large sample of developing and emerging economies (1970-2015) I find that reputation and spillover effects dominate in terms of economic significance; there is less convincing evidence for punishment effects or political factors. In robustness checks I allow for the transmission of each theory strand through macro-fundamentals, account for capital controls, debt relief, and capital flow bonanzas, investigate domestic, private and present-value external debt, and conduct sample splitting exercises (by exchange rate arrangement, political regime, financial development, and time period). Though they provide more refined insights into the differential mechanisms at work, none of these exercises substantially alter the above conclusions.