Is to Forgive to Forget? Sovereign Risk in the Aftermath of a Default

Abstract

We examine the link between sovereign defaults and credit risk, by taking into account the depth of a debt restructuring and by distinguishing between commercial and official debt. The focus is on debt restructuring events, which take place at the end of a default spell. We use a novel methodology (Jorda and Taylor 2016) to estimate the average treatment effect of a default episode on our outcome variables, agency ratings and bond yield spreads, accounting for the endogeneity of the default. Our results show that the average treatment effect on ratings is negative (and positive for bond spreads) up to seven years following a default, while the opposite holds for a default with official creditors. Our results are robust to using a panel analysis, which allows us to investigate on the importance of the (final) haircut size. Specifically, we and that the rating (spread) variation (increase) is larger for cases with deeper haircuts. Therefore, we and evidence that official and private defaults may have different costs and then induce selective defaults.