Sovereign risk, debt composition and exchange rate regimes

Abstract

Domestic and foreign debt risks, like exchange rate fluctuations and defaults, are influenced by the exchange rate regime. Analyzing data from 2004 to 2021 for 46 economies, we find that risk increases with higher public debt-to-GDP ratios (size effect), and a larger proportion of foreign debt (composition effect). However, the effects vary based on exchange rate regimes: composition effect is strong in floating, ambiguous in managed, and absent in monetary unions. The size effect is strong in monetary unions, weak in floating, and absent in managed regimes.