The Role of International Political Stability on Two-Centuries of Sovereign Defaults

We study the effects of international political stability on sovereign defaults and bank-sovereign nexus. We construct a novel index (IPS) that quantifies the course of international relations between 149 countries spanning 1840-2012. We show that countries with higher IPS scores are less likely to default on their debt as they benefit from larger capital inflows, better terms of trade, and lower financial risk. Moreover, such countries benefit from a weak bank-sovereign nexus, enabling them to rebound easier with a mild credit-crunch shock should they default. Similarly, high IPS helps a defaulting country to mitigate increased reputation costs, including sovereign rates and credit ratings. Although higher debt-to-GDP ratio and inflation are associated with a higher frequency of sovereign debt crises, international political stability alleviates these adverse effects