Sovereign Defaults: The Price of Haircuts

Cruces, Juan J.; Trebesch, Christoph

doi:10.1257/mac.5.3.85

Cited by 382 publications

(587 citation statements)

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“…However, for the majority of the countries studied here, the LGD fluctuated at levels comfortably below 20% for most of the sample. To put these numbers into perspective, it is worth noting that the actual average LGD of all sovereign debt restructurings in the world between 1970 and 2010 was 50%, and 50% was also the loss suffered by investors following the restructuring of Russian debt in 1998 (Cruces and Trebesch, 2013). The largest LGD recorded in our results (50%) would also be roughly aligned with a Standard and Poor's 'recovery rating' of 3.…”

Section: The Estimates Of the Pds Andsupporting

confidence: 58%

Market perception of sovereign credit risk in the euro area during the financial crisis

Camba-Méndez

Serwa

2016

The North American Journal of Economics and Finance

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractWe study market perception of sovereign credit risk in the euro area during the financial crisis. In our analysis we use a parsimonious CDS pricing model to estimate the probability of default (PD) and the loss given default (LGD) as perceived by financial markets. We find that separate identification of PD and LGD appears empirically tractable for a number of euro area countries. In our empirical results the estimated LGDs perceived by financial markets stay comfortably below 40% in most of the samples. We also find that macroeconomic and institutional developments were only weakly correlated with the market perception of sovereign credit risk, whereas financial contagion appears to have exerted a non-negligible effect.JEL-Classification: C11, C32, G01, G12, G15. Keywords: sovereign credit risk, CDS spreads, euro area, probability of default, loss given default.ECB Working Paper 1710, August 2014 1 Executive summaryThe aim of this paper is to study market perception of sovereign credit risk in the euro area during the financial crisis. Understanding the factors that influence changes in market perception of sovereign credit risk is a question of special interest for economists, investors, and financial regulators. Similarly to a number of recent studies, we also monitor the market perception of sovereign risk by using information derived from CDS spreads.In studying market perceptions of sovereign credit risk, one of the aims of this paper is to estimate measures of the probability of default (PD) as perceived by financial markets and the loss given default (LGD), also as perceived by financial markets, embedded in the CDS spreads. Earlier studies of the euro area sovereign debt crisis usually employed the CDS spreads alone and thus were not able to separately identify changes in the valuation of risk stemming from either increases of potential losses or a growing likelihood of default.Yet, in the pricing framework of 'fractional recovery of face value', the factors governing the dynamics of the PD and LGD play very distinct roles in the derivation of the price of the CDS contract, thus suggesting that PD and LGD can indeed, at least in theory, be separately identified. However, what is conceptually true may not always hold empirically, and to date the separate identification of PD and LGD remains challenging.The second aim of this paper is to shed some light on the key drivers of the market perception of ...

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Section: The Estimates Of the Pds Andsupporting

confidence: 58%

Market perception of sovereign credit risk in the euro area during the financial crisis

Camba-Méndez

Serwa

2016

The North American Journal of Economics and Finance

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“…To do this, however, the sovereign must forego putting its assets to more productive use. For example, it cannot buy commercial goods or borrow money in a jurisdiction where creditors might seize the goods or the loan proceeds (Schumacher et al 2014;Cruces and Trebesch 2013;Shleifer 2003). The cost of these foregone opportunities might induce the sovereign to pay (Weidemaier and Gelpern 2014 As noted, the law on the books was less clear here, but a case could be made that a sovereign could waive execution immunity by the early to mid-twentieth century.…”

Section: Absolute Immunity As a Mandatory Rulementioning

confidence: 98%

Differing Perceptions? Market Practice and the Evolution of Foreign Sovereign Immunity

Weidemaier¹,

Gulati

2016

SSRN Journal

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The 20th century witnessed a transformative, "tectonic" shift in international law, from "absolute" to "restrictive" theories of sovereign immunity. As conventionally understood, however, this dramatic transformation represented only a shift in the default rule. Under absolute immunity, national courts could not hear lawsuits and enforce judgments against a foreign sovereign without its consent. Under restrictive immunity, foreign sovereigns were presumptively not immune when they engaged in commercial acts. We demonstrate that market practices undermine this conventional understanding. Using an extensive, twocentury data set of contracts between foreign governments and private creditors, we show that contracting parties have long treated absolute immunity as akin to a mandatory rule, which they could not reliably change by contract. By contrast, we show that the Foreign Sovereign Immunities Act in the U.S. and the State Immunities Act 1978 in the U.K.-two statutes largely overlooked by international law scholarship-fundamentally reordered a global market for contracts. We explore why the conventional narrative, which relies on analysis of traditional legal materials, is at such odds with the "law on the ground." 2

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“…Also, in line with that latter literature, defaults are partial, while most of the strategic default literature assumes default to be a 0-1 decision, once a sovereign defaults it defaults on all outstanding debt. However this is mostly an ad hoc assumption made to avoid having to endogenize post-default bargaining, and in striking contradiction of almost all actual sovereign defaults (Cruces and Trebesch 2013). Finally since we do not model default as the outcome of a strategic choice, there is no need to incorporate an explicit punishment mechanism (like exclusion of capital markets after a default).…”

Section: Governmentmentioning

confidence: 99%

Sovereign debt and bank fragility in Spain

Kwaak

Wijnbergen

2016

Rev World Econ

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In May 2012 the Spanish government announced a debt-financed recapitalization of the undercapitalized Spanish banking system. Although there was a wide consensus among economists and policymakers that this was key to solving Spain's economic troubles, both bank CDS and sovereign CDS further increased in the days following the announcement while lower bank CDS spreads were expected. Higher sovereign debt discounts deteriorated the fiscal position of the Spanish government. We propose a mechanism that can explain the events in Spain, namely the interaction whereby weak banks that are heavily exposed to risky domestic sovereign debt and weak government finances set off a negative amplification cycle: additional debt issue leads to higher sovereign debt discounts, resulting in capital losses on existing sovereign debt, deteriorating the capital base of banks, additional rounds of interest rate increases, a perverse amplification cycle substantially offsetting the initial recapitalization. We construct a DSGE model with balance-sheetconstrained financial intermediaries that finance private loans to the real economy, as well as sovereign debt subject to sovereign default risk. We calibrate the model to Spanish data, and find that our model is capable of matching the developments in the sovereign bond market in Spain in May/June 2012 quite well. We investigate anWe acknowledge the generous support of the Dutch Organization for Sciences, through the NWO Research Talent Grant No. 406-13-063. We thank Matthijs Knijnenburg for excellent research assistance. Electronic supplementary material

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Sovereign Defaults: The Price of Haircuts

Cited by 382 publications

References 48 publications

Market perception of sovereign credit risk in the euro area during the financial crisis

Market perception of sovereign credit risk in the euro area during the financial crisis

Differing Perceptions? Market Practice and the Evolution of Foreign Sovereign Immunity

Sovereign debt and bank fragility in Spain

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