Sovereigns Going Bust: Estimating the Cost of Default

BSGE Discussion Paper 2016/1. This paper estimates the cost of sovereign default by using novel econometric methods – dynamic local projections applied to a sample that is re-randomised using inverse propensity score weights. We find that the impact of default on output is negative, significant and persistent – around 2.8% of GDP on impact and 4.8% at peak. The downturn is driven by sharp falls in investment, accompanied by a collapse in gross trade. The cost rises dramatically if the default is followed by a systemic banking crisis, peakingat 9.5% GDP. Our findings suggest that while autarky costs play an important role,sovereign-banking spillovers are central to the cost of default.

Read the full paper