Sovereign Debt Crises in Latin America: A Market Pressure Approach

ABSTRACT

We construct a continuous sovereign debt crisis index for four large Latin American countries for the period 1870−2012. To obtain the optimal set of indicators and the optimal value of the threshold for dating crises we apply the receiver operating characteristic (ROC) curve. Our sovereign debt crisis index is a weighted average of three indicators: the debt-to-GDP ratio, the external interest rate spread, and the exports-to-imports ratio. The continuous index allows a more advanced analysis of sovereign debt crises as illustrated with an investigation of the relationship between sovereign debt crises and business cycles in Latin America.

KEY WORDS:

• debt crisis index
• receiver operating characteristic (ROC) curve
• sovereign debt crises

Acknowledgements

The authors thank Xiaoli He for excellent research assistance, Elmer Sterken for helpful discussions, Rodrigo Caputo, Ana Maria Chirinos, Greetje Frankena, Laurie Reijnders, Fernando Rosas, Alan Taylor, and participants at the LACEA-LAMES 2013 conference in Mexico City, the IFABS 2014 conference in Lisboa, Portugal, the ICFBR 2014 conference in Brasilia, Brazil, and seminars at the University of Groningen and Universidad de Guadalajara, and the editor and two referees for comments and suggestions.

Notes

1. We refer to Appendix A for an overview of alternative definitions of sovereign debt defaults and sovereign debt crises.

2. Alternatives to evaluate the signals of binary variables are the area under the curve, and, as a special case, the Youden index. These methods do not make a distinction between false alarms and missed crises; these events have the same weight.

3. Missing observations for Argentina 1961–92, Chile 1957–99, Mexico 1895–1995.

4. A combination that yields similar results in performance consists of the debt-to-GDP ratio and the ratio of exports to imports.

5. Experimenting with different lags, or including exogenous variables like the US long-term interest rate and US real GDP growth yields similar impulse response functions.