The Costs of (Sub)Sovereign Default Risk: Evidence from Puerto Rico

54 Pages Posted: 8 Dec 2017  

Anusha Chari

University of North Carolina (UNC) at Chapel Hill - Department of Economics; National Bureau of Economic Research (NBER)

Ryan Leary

University of North Carolina (UNC) at Chapel Hill, College of Arts and Sciences, Department of Economics

Toan Phan

Federal Reserve Banks - Federal Reserve Bank of Richmond

Multiple version iconThere are 3 versions of this paper

Date Written: December 3, 2017

Abstract

Puerto Rico’s unique characteristics as a U.S. territory allow us to examine the channels through which (sub)sovereign default risk can have real effects on the macroeconomy. Post-2012, during the period of increased default probabilities, the cointegrating relationship between real activity in Puerto Rico and the U.S. mainland breaks down and Puerto Rico spirals into a significant decline. We exploit the cross-industry variation in default risk exposure to identify the impact of changes in default risk on employment. The evidence suggests that there are significantly higher employment growth declines in government demand and external finance dependent industries. An additional real effect of default anticipation is that heightened default risk Granger causes Puerto Rico’s austerity measures. An event study analysis using government bond yields and stock returns confirms that news of increased default risk increases the cost of capital for the Puerto Rican government and for publicly traded Puerto Rican firms.

Keywords: sovereign debt, default risk, growth employment, cost of capital, external finance dependence, government demand

JEL Classification: F3, F4, G15

Suggested Citation

Chari, Anusha and Leary, Ryan and Phan, Toan, The Costs of (Sub)Sovereign Default Risk: Evidence from Puerto Rico (December 3, 2017). Available at SSRN: https://ssrn.com/abstract=3081883 or http://dx.doi.org/10.2139/ssrn.3081883

Anusha Chari

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Chapel Hill, NC 27599
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ryan Leary

University of North Carolina (UNC) at Chapel Hill, College of Arts and Sciences, Department of Economics ( email )

Chapel Hill, NC 27599
United States

Toan Phan (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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