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A Quantitative Theory of Hard and Soft Sovereign Defaults

Author

Listed:
  • Grey Gordon

    (FRB Richmond)

  • Pablo Guerron-Quintana

    (Boston College)

Abstract
Empirical research on sovereign default shows "hard defaults"---defined as defaults with above-average haircuts---have worse outcomes for GDP growth than "soft defaults" and that sovereigns continue to borrow post-default. We propose a model capable of capturing these and other empirical regularities. In it, the sovereign makes period-by-period decisions of whether to make the prescribed debt payments or not. Hard defaults arise when the sovereign repeatedly \emph{chooses} to not pay over the course of many years. Unlike in the standard model, default does not exogenously result in autarky. Rather, autarky-like conditions arise endogenously as the shocks leading to default result in higher spreads than the sovereign is willing to pay. The calibrated model predicts that growth shocks are the main determinant of whether default is hard or soft. We use the model and the particle filter to decompose how much of the empirical correlation between default intensity and output growth is selection and how much is causal. Decomposition of model forces shows that one-third (one-tenth) of hard (soft) defaults are explained by actual default costs with the rest explained by selection. A historical decomposition of shocks reveals that transitory shocks and trend shocks were the primary drivers of the Argentinean defaults in the 1980s and the 2000s, respectively. Estimated haircuts were 20 percentage points higher in the 2001 default than in the one in the 1980s, consistent with the data. Our estimated productivity shocks coincide with major events such as the convertibility plan and the Asian crisis.

Suggested Citation

  • Grey Gordon & Pablo Guerron-Quintana, 2019. "A Quantitative Theory of Hard and Soft Sovereign Defaults," 2019 Meeting Papers 412, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:412
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    References listed on IDEAS

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    1. Maximiliano Dvorkin & Juan M. Sánchez & Horacio Sapriza & Emircan Yurdagul, 2021. "Sovereign Debt Restructurings," American Economic Journal: Macroeconomics, American Economic Association, vol. 13(2), pages 26-77, April.
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    19. Maximiliano Dvorkin & Emircan Yurdagul & Horacio Sapriza & Juan Sanchez, 2018. "Sovereign Debt Restructuring: A Dynamic Discrete Choice Approach," 2018 Meeting Papers 1273, Society for Economic Dynamics.
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    Cited by:

    1. Xavier Mateos-Planas & Jose-Victor Rios-Rull & Cristina Arellano, 2013. "Partial Default," 2013 Meeting Papers 765, Society for Economic Dynamics.
      • Cristina Arellano & Xavier Mateos-Planas & José-Víctor Ríos-Rull, 2019. "Partial Default," Staff Report 589, Federal Reserve Bank of Minneapolis.
      • Cristina Arellano & Xavier Mateos-Planas & Jose-Victor Rios-Rull, 2019. "Partial Default," Discussion Papers 1911, Centre for Macroeconomics (CFM).
      • Cristina Arellano & Xavier Mateos-Planas & José-Víctor Ríos-Rull, 2019. "Partial Default," NBER Working Papers 26076, National Bureau of Economic Research, Inc.
    2. Xuan Wang, 2019. "When Do Currency Unions Benefit From Default ?," 2019 Papers pwa938, Job Market Papers.
    3. Xuan Wang, 2021. "Bankruptcy Codes and Risk Sharing of Currency Unions," Tinbergen Institute Discussion Papers 21-009/IV, Tinbergen Institute.
    4. Mingzhuo Deng & Pablo A. Guerron-Quintana & Lewis Tseng, 2023. "Parallel Computation of Sovereign Default Models," Computational Economics, Springer;Society for Computational Economics, vol. 62(3), pages 1047-1085, October.
    5. Marchesi, Silvia & Masi, Tania, 2021. "Life after default. Private and official deals," Journal of International Money and Finance, Elsevier, vol. 113(C).
    6. Mitchener, Kris & Trebesch, Christoph, 2021. "Sovereign Debt in the 21st Century: Looking Backward, Looking Forward," CEPR Discussion Papers 15935, C.E.P.R. Discussion Papers.

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