# **3. Creditor losses in historical perspective**

This section shows that creditor losses due to default and restructuring events occur fairly often in external sovereign debt markets. However, the losses are almost always partial. Debt repudiations (unilateral debt cancelations) are rare, and defaults typically end in a negotiated settlement with haircuts well below 100%.

As explained in the introduction, we follow the international macro literature and use the term “haircut” to describe the size of creditor losses suffered in a sovereign default and debt restructuring. Finance scholars and practitioners also refer to “loss given default” (LGD), or one minus the “recovery rate” of a bond, which is exactly what our haircut estimates aim to capture for sovereign defaults. There is no consensus on the exact measurement of corporate bond recovery rates, however (see the survey by Altman 2011). Most but not all contributions use bond prices to approximate creditor losses in a corporate default, but the dating to choose the relevant bond price differs. Some contributions choose an (arbitrary) date at the start of default, for example, the bond price 90 days post-default (Moody’s 2011a; Jankowitsch, Nagler, and Subrahmanyam 2014), while others focus on bond prices at the exit from default (e.g., Moody’s 2007). The latter approach is sometimes called “ultimate recovery rates” and is conceptually close to ours since we compute haircuts at the restructuring date (default exit). Moreover, in Appendix C2.3 we show that our haircut estimates have a high correlation with bond prices at the start of default (for 94 cases for which prices were available).<sup>23</sup> In sum, our haircut estimates can be regarded as a valid measure of sovereign LGDs in the vein of existing corporate LGD databases.

# 3.1. Sovereign debt restructurings, 1815–2016

To estimate haircuts requires moving well beyond identifying the incidence of debt crises, as in Reinhart and Rogoff (2009) and others. We conduct a census of all distressed sovereign debt restructurings with foreign commercial creditors from 1815 to 1980. We then combine this historical sample with the updated restructuring and haircut dataset of Cruces and Trebesch (2013), which covers 1978–2013, and with Fang, Schumacher, and Trebesch (2020), to add events until 2016. The result is a full sample of sovereign debt restructurings with foreign banks and bondholders for 1815–2016. To select cases, we apply the same criteria as in Cruces and Trebesch (2013) and focus on:

- (i) Distressed restructurings, defined as exchanges of debt at a loss (as in Moody’s 2012).

- (ii) Restructurings of external sovereign debt, meaning bonds or loans by the central government and owed to private, foreign creditors, that is, international banks or bondholders. We do not include sub-sovereign bonds (as these are a separate asset class), private-to-private debt

> 23 One can use the bond prices in our database to compute any price-based recovery rates of choice. Figure C.3 in the Appendix does so, using sovereign bond prices at the _start_ of default (90 days post-default, as in Moody’s 2011a), and compares them to our set of haircut estimates at _exit_ from default (we compute discounted payment streams at the restructuring date). The two measures are highly correlated, suggesting that, at the entry into default, the market does well at predicting recovery rates at the exit from default.

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