Partial default
In this paper, Arellano et al. challenge the traditional view that partial default is a period of impasse with no repayments and no borrowings and that default episodes lead to a reduction in debt. They look at partial default and default episodes using 50 years of data for 37 emerging markets and find that sovereigns default partially on about 35% of the yearly amount they owe, and often about a third of the time. Default episodes last on average nine years, yet about 35% of episodes last fewer than two years. During default episodes partial default and debt continue to rise, reaching on average 28% and 40%, respectively, in the middle of the episode.
The authors develop a model where the sovereign government in a small open economy borrows long-term bonds, can choose to partially default on its debt payments, and faces a stochastic stream of income. Their model shows that:
- Partial default is a flexible way to intertemporally transfer resources in addition to traditional borrowing. Partial default amplifies debt crises because the defaulted payments accumulate and new borrowing occurs at increasingly high interest rates; both of these factors increase future indebtedness.
Partial Default
Authors: Cristina Arellano, Xavier Mateos-Planas, José-Víctor Ríos-Rull
From: Federal Reserve Bank of Minneapolis, University of Pennsylvania, Queen Mary University of London
Politics and default
In this paper Azzimonti and Mitra analyze the government’s incentives to default under different degrees of political constraints using a political-economy model of fiscal policy. In particular, they examine whether less constrained governments are sometimes more powerful and able to take unpopular austerity measures whenever necessary and hence avoid default; or whether less constrained governments tempt the politicians to default and misuse available resources whenever possible.
They use a Markov perfect equilibrium, and solve an infinite horizon version of the model numerically and calibrate it to Argentina in the period surrounding the 2001/2002 crisis. In their model legislators bargain over taxes, general spending, debt repayment, and a local public good that can be targeted to the region they represent. They find that:
- Under tighter political constraints, more legislators have veto power, implying that local public goods need to be provided to a larger number of regions. As a result, the resources that are freed after a default have to be shared with a higher number of individuals, which reduces the benefits from defaulting in per-capita terms. This lowers the incentive to default compared to the case with lax political constraints.
- Default is more rewarding for the less constrained government because the released resources are distributed as local public goods among fewer legislators. Even if defaulting does not release resources to provide for local public goods in the current period, current default incentives are affected by the possibility of wasteful local public goods provision in the future periods.
Political Constraints and Sovereign Default
Authors: Marina Azzimonti, Nirvana Mitra
From: Stony Brook University, Shiv Nadar University
A News-implied Sovereign Risk Index
Dim et al. construct a measure of sovereign default risk, namely the News-implied Sovereign Risk Index (NSRI), from news media that can be computed for any country in real-time and that is particularly relevant for developing and emerging markets without liquid market proxies of default risk. They look at 10 million news articles covering over 100 countries from the PressReader News API and then they apply two relatively simple yet powerful ML techniques—topic modelling and text similarity—to quantify the degree of sovereign default concerns reflected in news articles. The authors show that:
- The NSRI is strongly associated with sovereign CDS spreads both contemporaneously and in predictive terms, predicts future sovereign rating downgrades, and captures default risk information not fully reflected in CDS spreads.
- When they apply the index to study how default concerns influence equity markets they find that equity markets overreact to global default concerns than country-specific concerns, which signals the relevance of global (push) factors for local asset prices.
News-Implied Sovereign Default Risk
Authors: Chukwuma Dim, Kevin Koerner, Marcin Wolski, Sanne Zwart
European Investment Bank
From: Frankfurt School of Finance & Management, European Investment Bank
