200 Years of Sovereign Haircuts and Bond Returns (with Josefin Meyer and Carmen Reinhart)

Abstract:

How do creditors fare in sovereign debt markets? In particular, when do they suffer losses on their bond holdings? These question have regained crucial relevance for investors and policymakers, in particular in advanced economies. In this paper, we take a long-run perspective and compute investor returns and investor losses (haircuts) in sovereign debt markets since 1815 and worldwide. To our knowledge, this is the most comprehensive dataset on sovereign bonds and debt crises ever compiled. The results provide unique new insights on the asset class of sovereign debt and put recent crisis experiences in emerging markets and in the Eurozone into historical perspective. The average long-run real return on emerging market sovereign bonds is about 6-7% over the past 200 years. This is significantly higher than the return on advanced country domestic sovereign bonds and resembles the return and volatility profile of domestic equities. With regard to creditor losses (haircuts) we find that their size and variation is strikingly similar over time, despite changes in institutions, financial markets and economic fundamentals since the 19th century. Cases of outright debt repudiation and bond price crashes (haircuts or price drops of more than 90 percent) are surprisingly rare. We also find that creditor losses are often quickly recovered.