assumed (e.g., Eaton and Gersovitz 1981, Aguiar and Gopinath 2006, Arellano 2008, Broner, Martin, and Ventura 2010).

Finally, our study is the first to offer a 200-year perspective of sovereign bond pricing. Compared with Mauro, Sussman, and Yafeh (2002), for example, we add 60 years of data pre-1870, as well as the entire spell before, during, and after WW1 and WW2, when co-movement in sovereign bond prices was higher than in the relatively tranquil pre-1913 spell. Our 200-year dataset has a monthly frequency and can be explored at the global, country, and bond levels.

The paper proceeds as follows. In the next section, we review the related literature, especially work measuring sovereign haircuts and investor returns. Section 3 describes credit events and investor losses (haircuts) on external sovereign debt across two centuries, while Section 4 moves beyond defaults and documents the history of sovereign bond prices and returns over the very long run. Section 5 explores the behavior of returns around debt crises to understand investors’ recoveries in this market. Section 6 focuses on risk-return comparisons across asset classes. Section 7 concludes and lays a path for future research.

# **2. Previous studies: Sovereign debt returns and haircuts**

The related literature can be broadly grouped into two categories: papers that quantify rates of return on sovereign debt or related emerging market investments and a literature that provides estimates of haircuts and recovery rates for sovereign credit events. By and large, our results on bond returns and haircuts turn out to be similar to the existing body of work, whenever meaningful comparisons are possible. The main contribution is to provide a much more comprehensive picture, covering all countries for which external bond data were available and spanning the complete 200-year picture.

In the literature on investor returns, several earlier papers calculate internal rates of return (IRRs) to assess how creditors have fared in sovereign debt markets (i.e., until the bond is extinguished). IRRs take the perspective of a buy-and-hold investor and discount cash flows over the life span of a debt instrument (from issuance until maturity or sample end).<sup>15</sup> IRRs have the benefit that they do not require collecting market prices, so that they can be calculated for all types of instruments, even for bonds not traded on the market. The main drawback of IRRs is that, despite requiring much data work, they provide only one data point per instrument, namely the bond’s return over the entire holding period. Indeed, IRRs assume that investors buy a sovereign bond instrument at issuance and never sell it. This is unlikely to be true for most investors, today and also prior to WW2 when sovereign bond maturities typically exceeded 30 years. Price-based returns are a more flexible measure and can be used to address a much broader range of

> 15 Specifically, IRRs (or I ) can be extracted from the cash flow data to yield a net present value of zero, as follows: C 0 = N 0 + ∑ ~~,~~ where is bond maturity, C are debt payments (coupon and amortization) in II I )<sup>tt</sup> TT rr tt year , and NN= −NN0 is the purchasing price, that is, the issue price of the bond.  tt=1 (1+rr II TT tt tt NN

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