Why Does Sovereign Risk Differ for Domestic and External Debt? Evidence from Scandinavia, 1938-1948
25 Pages Posted: 3 Aug 2010
Date Written: May 12, 2009
This study shows empirically that the political costs of sovereign default can differ considerably for domestic and external debt. The analysis uses new evidence from Danish and Swedish bond markets around World War II, a time when markets went from being fully integrated to fully segmented overnight. By linking the exogenous wartime shocks to changes in default costs on domestic and external debt, it is found that these costs explain a significant part of the variation in the sovereign yield spread across markets. The results suggest that governments can choose strategically on which debt, the domestic or the external, to default on, and that this decision hinges on the relative size of the political default costs.
Keywords: Sovereign Risk, Domestic Debt, External Debt, Market Segmentation, Cliometrics
JEL Classification: F34, G15, G18, N20, N24, N44
Suggested Citation: Suggested Citation