approach, however, is not viable for external sovereign debt, due to the many defaults in this market and because defaults come in different varieties and can affect bonds differently, resulting in heterogeneous outcomes (Meyer 2021). A rigorous calculation of total returns on external sovereign bonds thus requires pricing data as well as details on the fate of each bond in default, in particular on the timing and scope of missed payments and detailed restructuring terms. This type of bond-level default data is much harder to collect and was not readily available prior to this study.

The second main building block is our new archive of external default and restructuring events. We compute creditor losses (haircuts) bond-by-bond and deal-by-deal and combine the information on restructuring outcomes with our monthly bond price data. Moreover, we trace missed or partial bond payments at a monthly frequency. Because, as we establish here, coupons are the main driver of total returns in this market, it is important to measure interest payments accurately, especially during lengthy default spells. What the data reveal is that sovereigns in default on principal payments often continue to service coupons in full or in part, which pushes up investor returns. Moreover, coupon payments on the same bond can vary markedly over the course of a crisis. The granular repayment track record thus allows us to build monthly total return series on a bond-by-bond basis in a consistent manner, as well as representative country and global portfolios over long time spans.

Thirdly, we compile an extensive supplementary database that provides unique insights into the liquidity of this asset class. We gathered monthly, bond-level bid-ask spreads over two centuries, covering 62% of our pricing sample (in total 165,638 observations, see Figure B3).

Our results are hard to reconcile with seminal quantitative models of sovereign default. Until recently, this literature assumed risk-neutral investors and sovereign risk premia that solely reflect the expected losses from default (e.g., Aguiar and Gopinath 2006; Arellano 2008; Mendoza and Yue 2012). When investors are risk-neutral, excess return above “risk-free” bonds should be zero in expectation. Yet, we find real excess returns that are in the range of 2% to 4% ex-post for the full global sample, although there is considerable time variation. Thus, investors typically receive a compensatory premium for holding sovereign risk that exceeds historical credit losses. This finding gives support to a growing body of quantitative work that assumes risk-averse (or uncertainty averse) creditors in this market.<sup>11</sup> The high returns we observe cannot be easily explained by historical default and recovery rates. Using our new default and restructuring database, we show that sovereign defaults do not usually wipe out the claims of private creditors. Almost all the defaults over the past 200 years have been solved by a debt exchange of old into new debt at a discount – with an average haircut of 44% and a standard deviation of

> Compared to these studies, we zoom in on one asset class and cover 91 countries, 200 years at monthly frequency, and instrument-level data.

> 11 See Barro’s discussion of rare disasters with Epstein-Zin preferences (Barro 2006) and, more recently, Broner, Lorenzoni, and Schmukler (2013), Lizarazo (2013), Borri and Verdelhan (2015), Aguiar et al. (2016), Grosse Steffen and Podstawski (2016), Pouzo and Presno (2016), and Asonuma and Joo (2018).

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