The Costs of Sovereign Default: Evidence from Argentina

By B ENJAMIN H ÉBERT AND J ESSE S CHREGER∗

We estimate the causal effect of sovereign default on the equity returns

of Argentine firms. We identify this effect by exploiting changes in the
probability of Argentine sovereign default induced by legal rulings in the
case of Republic of Argentina v. NML Capital. We find that a 10 percent
increase in the probability of default causes a 6 percent decline in the
value of Argentine equities and a 1 percent depreciation of a measure of
the exchange rate. We examine the channels through which a sovereign
default may affect the economy.

A fundamental question in international macroeconomics is why governments repay their

debt to foreign creditors, given the limited recourse available to those creditors. The semi-
nal paper of Eaton and Gersovitz (1981) argues that reputational concerns are sufficient to
ensure that sovereigns repay their debt. In a famous critique, Bulow and Rogoff (1989b)
demonstrate that reputation alone cannot sustain sovereign borrowing in equilibrium, with-
out some other type of default cost or punishment. The size and features of this cost
also play a key role in quantitative models of sovereign debt, beginning with Aguiar and
Gopinath (2006) and Arellano (2008). Numerous empirical papers have been written trying
to find the source and measure the size of these costs. The fundamental identification chal-
lenge is that governments usually default in response to deteriorating economic conditions,
which makes it hard to determine if the default itself caused further harm to the economy.
The case of Republic of Argentina v. NML Capital provides a natural experiment to
identify the causal effect of sovereign default. Following Argentina’s sovereign default in
2001, NML Capital, a hedge fund, purchased some of the defaulted bonds and refused to
join other creditors in restructurings of the debt that occurred in 2005 and 2010. Instead,
because the defaulted debt was issued under New York law, NML sued the Argentine gov-
ernment in U.S. courts to receive full payment. To compel the Argentine government to
repay the defaulted debt, the U.S. courts blocked Argentina’s ability to pay its restructured
creditors, unless NML and the other holdout creditors also received payments. The Argen-
∗ Hébert: Graduate School of Business, Stanford University, 655 Knight Way, Stanford CA 94305 (e-mail: bhe-
bert@stanford.edu). Schreger: Harvard Business School and NBER, Soldiers Field, Boston, MA 02163 (e-mail:
jschreger@hbs.edu). We thank Laura Alfaro, Joaquin Blaum, Luigi Bocola, John Campbell, John Cochrane, Jeff Frieden,
Gita Gopinath, Ed Glaeser, Paul Goldsmith-Pinkham, Réka Juhász, Eduardo Levy Yeyati, Matteo Maggiori, Mikkel
Plagborg-Møller, Monika Piazzesi, Ken Rogoff, Martin Schneider, Alex Roth, Mary Bryce Millet Steinberg, Chris Tonetti,
Christoph Trebesch, and Victoria Vanasco for helpful conversations. We thank the co-editor and three anonymous refer-
ees for comments that helped improve the paper. We thank Vivian Yue, Andreas Stathopoulos, and Graciela Kaminsky for
excellent discussions. We thank Brent Neiman for feedback and for generously sharing data. We thank Chloe Peng and
Kimberly Hagan for assistance preparing the paper for publication. We thank seminar audiences at the NBER IFM Spring
Meetings, NBER Capital Flows and Debt in Emerging Markets Conference, the SED Annual Meeting, NYU Stern, Princeton,
MIT, Stanford, Northwestern, Berkeley, UNC Kenan-Flagler, Michigan Ross, Cambridge, the Chicago International Macro-
Finance Conference, the American Economic Association annual meetings, the Boston Area Juniors Macro Group, and DIW
Berlin. We thank Stephen King, Vivek Anand, and Tom Adney of Markit for useful discussions about the data. Christine
Rivera provided excellent research assistance. Portions of this research were conducted during post-doctoral fellowships at
the economics departments of Stanford (Hébert) and Princeton (Schreger). All errors are our own. The authors declare that
they have no relevant or material financial interests that relate to the research described in this paper.
tine government resisted paying the holdouts, even though the required payments would be
small relative to the Argentine economy. As a result, legal rulings in favor of NML raised
the probability that Argentina would default on its restructured bonds, while rulings in favor
of Argentina lowered this probability.
We argue that these legal rulings are exogenous shocks to the risk-neutral probability of
default1 that allow us to identify the causal effect of sovereign default on the market value
of Argentine firms. Our key identifying assumption is that the information revealed to mar-
ket participants by these legal rulings affects firms’ stock returns only through the effect on
the sovereign’s risk-neutral probability of default. This assumption requires that the judges
in U.S. courts making these rulings do not have private information about the Argentine
economy. This assumption also requires that the firms we study are not directly affected by
the rulings. Consistent with this assumption, Argentine firms are legally separate from the
federal government of Argentina and are not subject to attachment of their assets by cred-
itors of the sovereign. We discuss other potential challenges to our identifying assumption
in more detail in section V.
We use credit default swaps (CDS) to measure the change in the risk-neutral probability
of default. Compiling rulings from the United States District Court for the Southern District
of New York, the Second Court of Appeals, and United States Supreme Court, we isolate
fifteen rulings that potentially changed the risk-neutral probability of default. We identify
the effect of changes in this default probability on equity returns through heteroskedasticity,
following Rigobon (2003) and Rigobon and Sack (2004).2 We describe this procedure and
our identification assumptions in detail in section III. We find that, for every 10 percent
increase in the five-year cumulative risk-neutral default probability around these rulings,
the U.S. dollar value of a value-weighted index of Argentine American Depository Receipts
(ADRs3 ) falls roughly 6 percent. Between January 3, 2011, when our data starts, and July
30, 2014, when Argentina defaulted, the risk-neutral five-year default probability increased
from roughly 40 percent to 100 percent. Linearly extrapolating our estimate of the causal
effect on log returns implies that this episode reduced the value of the Argentine firms in
the index by 30 percent. We also find that a 10 percent increase in the five-year cumulative
risk-neutral default probability causes a 1 percent depreciation in our preferred measure of
the Argentine unofficial exchange rate.4 The most direct interpretation of the risk-neutral
default probability changes and stock returns we study is that they reflect changes in the
actual probability of default and the expected value of the stream of dividends paid by the
firms. However, alternative interpretations are possible, and we discuss them in section V.
To better understand how this sovereign default was expected to affect the economy, we
examine which types of firms are harmed more or less by an increase in the probability of
default. We sort firms along the dimensions suggested by the theoretical sovereign debt
1 In our context, the “risk-neutral probability of default” is the probability that a risk-neutral agent would have to assign
to Argentina defaulting within the next five years to be indifferent between buying and selling a credit default swap on
Argentina. The actual, or physical, default probability could differ from the risk-neutral probability if market participants
are risk-averse with respect to Argentine default. Computing the risk-neutral probability of default from credit default swap
prices involves several assumptions (see appendix Section A.4).
2 In appendix Section D, we run a traditional event study, and find similar results.
3 ADRs are shares in foreign firms that trade on U.S. stock exchanges in U.S. dollars.
4 We focus on unofficial measures of the exchange rate because Argentina had capital controls during this period. These
measures are discussed in section II.D.
2
literature,5 as well as on some additional firm characteristics. We find suggestive evidence
that foreign-owned firms, exporters, banks,6 and large firms are hurt more by increases
in the probability of sovereign default than would be expected, given their “beta” to the
Argentine market and exchange rate.
This paper contributes to a large empirical literature examining the costs of sovereign
default, surveyed by Borensztein and Panizza (2009) and Tomz and Wright (2013). Using
quarterly time series, Levy Yeyati and Panizza (2011) find that output generally falls in
anticipation of a sovereign default and that the default itself tends to mark the beginning
of the recovery. Rose (2005) documents that bilateral trade between creditor countries and
debtor countries falls after a default. Acharya et al. (2014) examine the effect of the Eu-
ropean sovereign debt crisis on syndicated loan supply and firm behavior. Arteta and Hale
(2008) observe that during a sovereign default, external credit to the private sector is re-
duced. Schumacher, Trebesch and Enderlein (2014) study sovereign debt litigation across
a range of countries over the past forty years. Using cross-country panel data, Gornemann
(2014) finds a persistent drop in output following a sovereign default. Methodologically, our
paper uses a natural experiment to estimate the causal effect of sovereign default. Fuchs-
Schundeln and Hassan (2015) survey the literature on natural experiments in macroeco-
nomics. Our cross-sectional analysis is methodologically related to Bernanke and Kuttner
(2005) and Gorodnichenko and Weber (2016).
This paper is also related to the literature on quantitative models of sovereign debt, ini-
tiated by Aguiar and Gopinath (2006) and Arellano (2008). This literature attempts to si-
multaneously explain sovereign default decisions, debt levels, credit spreads, and business
cycle facts for emerging market countries. In many of these papers, the magnitude of the ex-
ogenous output cost of default is one of the key parameters that determines the equilibrium
quantity of debt issued and the incidence of default. This literature also emphasizes the
cyclical properties of the output cost (Arellano (2008), Chatterjee and Eyigungor (2012))
necessary to explain the observed facts, and develops theories to explain the source of these
costs (Mendoza and Yue (2012), Gornemann (2014), Perez (2014), Bocola (Forthcoming)).
Our evidence speaks to both the size and source of these costs, but further work is needed
to relate our findings to this class of models.
This paper is structured as follows: Section I discusses the case of Republic of Argentina
v. NML Capital. Section II describes the data and presents summary statistics. Section III
presents our estimation framework and results. Section IV discusses the firm characteristics
that are associated with larger responses to changes in the probability of default. Section
V discusses institutional details and alternative interpretations of the results. Section VI
concludes.

5 Bulow and Rogoff (1989a), Mendoza and Yue (2012), and Cole and Kehoe (1998) motivate us to study exporting
firms, importing firms, and foreign-owned firms, respectively. Numerous authors (e.g. Bolton and Jeanne (2011), Acharya,
Drechsler and Schnabl (2014), Gennaioli, Martin and Rossi (2014), Perez (2014), and Bocola (Forthcoming)) have offered
explanations for why banks would be particularly harmed by sovereign default.
6 Our point estimates are negative and economically significant for banks, consistent with the theoretical literature, but
our standard errors are too large to reject the hypothesis of no differential effects.
3
 I. Argentina’s Sovereign Debt Saga

In 2001, Argentina entered a deep recession, with unemployment reaching 14.7 percent
in the fourth quarter of that year. In December 2001, after borrowing heavily from the
International Monetary Fund (IMF), Argentina defaulted on over $100 billion in external
sovereign debt and devalued the exchange rate by 75 percent.7
The Argentine government then spent three years in failed negotiations with the IMF, the
Paris Club, and its private creditors. In January 2005, Argentina presented a unilateral offer
to its private creditors, which was accepted by the holders of $62.3 billion of the defaulted
debt. Despite the existence of the holdout creditors, S&P declared the end of the Argentine
default in June 2005 and upgraded Argentina’s long-term sovereign foreign currency credit
rating to B-. In 2006, Argentina fully repaid the IMF, and Argentina reached an agreement
with the Paris Club creditors in May 2014.
In December 2010, Argentina offered another bond exchange to the remaining holdout
creditors. Holdout private creditors who were owed $12.4 billion of principal agreed to the
exchange. Following this exchange, on December 31, 2010, the remaining holdout creditors
were owed an estimated $11.2 billion, split between $6.8 billion in principal and $4.4 billion
in accumulated interest.8 At this point, Argentina had restructured over 90 percent of the
original face value of its debt.
Following the 2010 debt exchange, the remaining holdout creditors—termed “vultures”
by the Argentine government—continued their legal battle. This litigation eventually cul-
minated in Argentina’s 2014 default on its restructured bondholders. The creditors, led
by NML Capital,9 argued that the Argentine government breached the pari passu clause,
which requires equal treatment of all bondholders, by paying the restructured bondholders
and refusing to honor the claims of the holdouts.
The case took several years to work its way through the U.S. courts, going from the
United States District Court for the Southern District of New York (“Southern District”), to
the United States Court of Appeals for the Second Circuit (“Second Circuit”), all the way
to the United States Supreme Court. These three courts issued numerous rulings between
December 2011, when Judge Thomas P. Griesa of the Southern District first ruled in favor
of the holdouts on the pari passu issue, and July 2014, when Argentina defaulted.
Following Griesa’s initial ruling in December 2011, years of legal wrangling ensued over
what this ruling meant and how it would be enforced. Griesa clarified that Argentina was re-
quired to repay the holdouts as long as it continued to the pay the restructured bondholders
(using a “ratable” payment formula). Argentina was not willing to comply with this ruling,
and continued to pay the restructured bondholders without paying the holdouts. Griesa then
ordered the financial intermediaries facilitating Argentina’s payments to stop forwarding
payments to the restructured bondholders, until Argentina also paid the holdouts. Griesa
7 Data and facts cited in this section are from Global Financial Data, Daseking et al. (2005), Hornbeck (2013), and Thomas
and Marsh (2014).
8 The interest on the defaulted debt has continued to accumulate since 2010, with the total amount owed reaching $15
billion in 2014 (Gelpern (2014a)). However, some of these claims may never be repaid, due to issues related to the statute of
limitations (Millian and Bartenstein (2016)).
9 Elliott Management Corporation, the parent company of NML, has a long history in litigating against defaulting
countries. See Gulati and Klee (2001) for a discussion of Elliott’s litigation against Peru, and Panizza, Sturzenegger and
Zettelmeyer (2009) for a literature review on the law and economics of sovereign default.
4
also ordered Argentina to negotiate with the holdouts, but the holdouts and the courts re-
jected Argentina’s offer of a deal comparable to the 2005 and 2010 bond exchanges. Ar-
gentina then twice appealed to the Supreme Court, with the Supreme Court declining to hear
either appeal. Following the decline of the second appeal on June 16, 2014, Griesa’s orders
were implemented, and Argentina had only two weeks before a coupon to the restructured
creditors was due. Against court orders, Argentina sent this coupon payment to the bond
trustee, Bank of New York Mellon (BNYM), but, as ordered by the court, BNYM did not
forward the payment to the restructured bondholders. Argentina’s restructured bonds did
not receive a coupon payment on June 30, which began a 30-day grace period. Negotia-
tions failed, and the International Swaps and Derivatives Association (ISDA) declared that
a credit event had occurred for credit default swaps referencing Argentina’s restructured
bonds on August 1, 2014. On September 3, 2014, the auction associated with the settle-
ment of the CDS contracts was held, and it resulted in a recovery rate of 39.5 cents on the
dollar.10

The cumulative effect of these legal rulings was to change the menu of options available
to Argentina. The status quo option, in which Argentina continued to pay its restructured
bondholders without paying the holdouts, became infeasible. Instead, Argentina could at-
tempt to settle with the holdouts and avoid defaulting on its restructured bondholders, or it
could default on the restructured bondholders.

Argentina effectively chose to default. In the simplest interpretation of these events,

making the required payments was not possible, and Argentina was forced to default by the
U.S. court system. This was the interpretation offered by a number of commentators in the
financial press (e.g. O’Brien (2014)). However, if a settlement was possible, the rulings
might have also raised the probability of a settlement. If Argentine firms would be affected
by a settlement, through some channel other than the avoidance of a sovereign default, then
the exclusion restriction of our experiment would not hold. In section V, we argue that
such channels are not plausible, because the amount of money required for a settlement
was small.

In November 2015, Argentina held a presidential election in which both of the candidates
in the run-off advocated a settlement with the holdouts. In April 2016, Argentina reached a
settlement with most of the holdouts, and the injunction preventing payments to the restruc-
tured bond holders was lifted (Platt and Mander (2016)). The settlement was reported as
being worth roughly 75 percent of the full value of the judgements obtained by the litigating
holdouts (Politi and Yuk (2016)), and will cost around $12.5 billion if it is eventually ac-
cepted by all of the holdouts (Mander and Moore (2016)). Around the same time, Argentina
issued $16.5 billion of new debt, for the stated purpose of repaying the holdouts, making
the restructured bonds current, and increasing Argentina’s dollar reserves.

10 The low recovery rate reflects both the decline in the price of Argentina’s bonds from 2011 to 2014, and the fact that
some (the “cheapest to deliver”) of Argentina’s bonds had relatively low coupons, and therefore low prices, when they were
issued.
5
 II. Data and Summary Statistics

A. Stock Market and CDS Data

Our dataset consists of daily observations of financial variables from January 3, 2011 to
July 29, 2014 (the day before Argentina most recently defaulted). We study the returns of
ADRs (U.S. dollar-denominated claims on underlying local equities) issued by Argentine
firms and traded in the United States, as well the returns of Argentine peso-denominated
equities traded in Argentina. The ADRs trade on the NYSE and NASDAQ, are relatively
liquid, and are traded by a wide range of market participants.11 However, using only the
ADRs limits our analysis to twelve firms that have exchange-traded ADRs. To study the
cross-sectional patterns of Argentine firms, we also examine the returns of firms traded
only in Argentina. The full list of firms included in our analysis, along with select firm
characteristics, is available in appendix Table 2.
The most commonly cited benchmark for Argentine ADRs is the MSCI Argentina Index,
an index of six Argentine ADRs. We also construct our own indices of ADRs, covering
different sectors of the Argentine economy. We classify Argentine firms by whether they are
a bank, a non-financial firm, or a real estate holding company. The industry classifications
are based on the Fama-French 12 industry classification and are listed in appendix Table
2. We construct value-weighted indices for the entire market and each of these industries,
except real estate.12 The value-weighted indices we construct exclude YPF, the large oil
company that was nationalized in 2012.
We use credit default swap (CDS) spreads to measure the risk-neutral probability of de-
fault. A CDS is a financial contract in which the seller of the swap agrees to insure the
buyer against the possibility that a reference entity (in this case, the Republic of Argentina)
defaults on a particular set of bonds issued by that entity. Once a third party, the Interna-
tional Swaps and Derivatives Association (ISDA), declares a credit event, an auction occurs
to determine the price of the defaulted debt. The CDS seller then pays the buyer the differ-
ence between the face and auction value of the debt. In appendix Section A.4, we provide
details on how Markit, our data provider, imputes risk-neutral default probabilities from the
term structure of CDS spreads using the ISDA Standard Model. We focus on the five-year
cumulative default probability, the risk-neutral probability that Argentina defaults within
five years of the CDS contract initiation.13
Because we want to capture the abnormal variation in Argentine CDS and equity returns
caused by changes in the probability of default, we would like to account for other global
11 Edison and Warnock (2004) document that ADRs that trade on the NYSE and NASDAQ are incorporated into U.S.
investors’ portfolios at float-adjusted market weights; that is, they are not subject to the “home bias” that causes U.S. investors
to underweight foreign stocks more generally. In contrast, several market participants have told us that capital controls and
related barriers were significant impediments to their participation in local Argentine equity markets during the time period
we study.
12 We do not include a value-weighted real estate index in the results because there are only two closely related firms in
this sector. We have also constructed equal-weighted indices, and found similar results.
13 We prefer the five-year cumulative default probability measure because we believe that shocks which move default
probability from (for example) one year ahead to two years ahead, without altering the cumulative default probability over
those two years, should have only a minimal impact on stock valuations. Our results are qualitatively robust to using the one-
or three-year cumulative default probability, and other CDS-based measures, subject to the caveat that the one- and three-year
cumulative default probabilities are more volatile than the five-year measure. Tenors longer than five years are not traded
frequently. See appendix Table 7 for details.
6
factors that may affect both measures. Controlling for these factors is not necessary, under
our identification assumptions, but can reduce the magnitude of our standard errors. To
proxy for risk aversion, we use the VIX index, the 30-day implied volatility on the S&P
500.14 We use the S&P 500 to measure equity returns and we use the MSCI Emerging
Markets Asia ETF to proxy for factors affecting emerging markets generally. We use the
Asia index to ensure that movements in the index are not directly caused by fluctuations in
Argentine markets. To control for aggregate credit market conditions, we use the Markit
CDX High Yield and Investment Grade CDS indices. We also control for crude oil prices
(West Texas Intermediate). These controls are included in all specifications reported in this
paper, although our results are qualitatively similar when using a subset of these factors, or
no controls at all. In our discussion, we will assume that the legal rulings we study do not
affect these controls; if this assumption were false, our estimates would measure the effect
of the legal rulings on firms above and beyond what would be expected, given the effects
on our control variables (see section IV for details).

B. Definition of Events and Non-Events

We build a list of legal rulings issued by Judge Griesa, the Second Circuit, and the
Supreme Court. We have created this list using articles in the financial press (the Wall Street
Journal, Bloomberg News, and the Financial Times), LexisNexis searches, and publicly
available information from the website of Shearman, a law firm that practices sovereign
debt law.
In appendix Section J, we list all of these events and links to the relevant source material.
Unfortunately, for many of the events, we are unable to determine precisely when the ruling
was issued. We employ several methods to determine the timing of rulings. First, we
examine news coverage of the rulings, using Bloomberg News, the Financial Times, and
LexisNexis searches. Sometimes, contemporaneous news coverage mentions roughly when
the ruling was released. Second, we use the date listed in the ruling. Third, many of rulings
are posted in the PDF electronic format, and have a “creation time” and/or “modification
time” listed in the meta-information of the PDF file, which provides suggestive but not
definitive evidence about when the ruling was released. In appendix Section J, we list the
information used to determine the approximate time of each ruling.
For our main analysis, we use two-day event windows. Consider the Supreme Court
ruling on Monday, June 16th, 2014. The two-day event window, applied to this event,
would use the CDS spread change from the close on Thursday, June 12th to the close on
Monday, June 16th. It would use stock returns (for both ADRs and local stocks) from 4pm
EDT on Thursday, June 12th to 4pm EDT on Monday, June 16th.15
For our two-day event windows, we choose our sample of non-events to be a set of two-
day risk-neutral default probability changes and stock returns, non-overlapping, at least two

14 See Longstaff et al. (2011) for discussion of the relationship between the VIX and sovereign CDS spreads.
15 For events occurring outside of daylight savings time in the eastern time zone, the local stocks close at 5pm ART (3pm
EST), while the ADRs use 4pm EST. We do not correct for this. For some events, we are certain about the day of the event.
For these events, we place the event on the first day of the two-day window; however, our results are robust to placing the
event on the second day of the two-day window instead (see appendix Section E.1). We also report our results using one-day
windows in appendix Section E.1.
7
days away from any event, and at least two days away from any of the “excluded events.”
“Excluded events” are legal rulings that we do not use, but also exclude from our sample of
non-events.16 For the heteroskedasticity-based identification strategy we employ, removing
these legal rulings increases the validity of our identifying assumption that the variance of
shocks induced by legal rulings is higher on event days than non-event days. However, our
results are robust to including these days in the set of non-events.

C. Summary of Events and Non-Events

In figure 3a, we plot the two-day change in the five-year risk-neutral default probability
and the two-day return of value-weighted index over our sample. Small data points in
light gray are non-events and the maroon/dark dots cover event windows in which a U.S.
court ruling was released. The details on each event can be found in appendix Section
J. In figure 3b, we construct the equivalent figure for the MSCI Mexico equity index and
the change in Argentina’s probability of default. Comparing the figure for the Argentine
value-weighted equity index with the figure for the Mexican index, we see that on the non-
event days, both stock indices co-move with our Argentine default probability measure.
However, on the event days, only the Argentine equity index co-moves with the Argentine
default probability measure. This observation suggests that omitted common factors might
not be very important on our event days, consistent with the result that our event studies
and heteroskedasticity-based identification strategy reach similar conclusions. In appendix
Section B, we present similar figures for the different sectors of the Argentine economy and
measures of the exchange rate.
[ Insert figure 3 here ]
In the table below, we present summary statistics for the returns of our value-weighted
ADR index and the changes in five-year risk-neutral default probabilities, during the
two-day event and non-event windows.
[ Insert table 1 here ]

D. Exchange Rates

We also study the effect of sovereign default on exchange rates. However, “the exchange
rate” was difficult to measure during this period. Argentina imposed capital controls in
2002, strengthened them in 2011, and then relaxed them at the end of 2015, after our sample
ends. During the 2011—2014 period, the official exchange rate diverged from the exchange
rates implied by other markets. We will consider three different measures of these parallel
exchange rates, known as the Blue Dollar. All of them are based on the rate at which
individuals could actually transact, subject to various transaction costs.
16 We exclude three rulings for which we could not find any contemporaneous media coverage. For one ruling, we could
not find the ruling itself. One of the rulings was issued on the Friday in October 2012 shortly before “Superstorm Sandy”
hit New York, and another the night before Thanksgiving. One of the legal rulings was issued at the beginning of an oral
argument, in which Argentina’s lawyers may have revealed information about Argentina’s intentions. Finally, we exclude the
ruling made on July 28th, 2014, because this ruling was made very close to the formal default date, and news articles on that
day focused on the last-minute negotiations, not the ruling. Our results are qualitatively similar when we include this ruling.
8
 The first unofficial exchange rate that we consider is the one that Argentines could use to
buy dollars from black market currency dealers. Dolarblue.net published this rate daily and
was the source many Argentines used as a reference for the exchange rate. This onshore
rate is known as the Dolar Blue or the Informal dollar, among many other names. This is
our preferred measure of Argentina’s market exchange rate.
The other two measures of the unofficial exchange rate we study come directly from
market prices and provide a way for onshore currency dealers to secure dollars. Both rely
on the fact that even though the Argentine peso was a non-convertible currency, securities
can be purchased onshore in pesos and sold offshore in dollars. The first class of instruments
for which this can be done are domestic law Argentine government bonds, and the exchange
rate associated with this transaction is known as the “blue-chip swap” rate. We can construct
a similar measure of the exchange rate, known as the “ADR blue rate,” by using equities
rather than debt. We describe the construction of both measures in appendix Section A.3.17
[ Insert Figure 1 here ]
In Figure 1, we plot all four of these exchange rates during our sample period. Throughout
this period, the official rate is significantly below the unofficial rates. The ADR blue rate
and the blue-chip swap rate are virtually indistinguishable (at low frequencies) during this
period, and co-move with the Dolar Blue rate.
The three parallel exchange rates we consider are not equivalent to a (hypothetical) freely
floating exchange rate. All three depend on local markets that were difficult for foreigners
to access, and were potentially subject to government intervention. We found news ar-
ticles stating that, during the 2011–2014 period, the Argentine government occasionally
intervened in local (peso-denominated) bond and stock markets to manage these parallel
exchange rates. Moreover, the premium demanded by black market currency dealers for
dollars would fluctuate based on the vigor with which the government prosecuted those
dealers (Parks and Natarajan (2013)).

E. Case Study: Supreme Court Announcement

For one of our events, we are able to precisely determine when the event occurred. On
June 16, 2014, the U.S. Supreme Court denied two appeals and a petition from the Repub-
lic of Argentina. The denial of Argentina’s petition meant that Judge Griesa could prevent
the Bank of New York Mellon, the payment agent on Argentina’s restructured bonds, from
paying the coupons on those bonds unless Argentina also paid the holdouts. Because Ar-
gentina had previously expressed its unwillingness to pay the holdouts, this news meant
that Argentina was more likely to default.18
The Supreme Court announces multiple orders in a single public session, and simulta-
neously provides copies of those orders to the press. SCOTUSBlog, a well-known legal
17 Auguste et al. (2006) explore how the convertibility of ADRs provides a way around capital controls. Both of our mea-
sures rely on Argentine local markets, which are illiquid, and therefore can be quite noisy at high frequencies. Pasquariello
(2008) documents that, for countries with convertible currencies, ADR parity does not always hold, and that the violations of
ADR parity are more common around financial crises. As a result, we should not necessarily expect our ADR-based measure
and the Dolar Blue to respond identically to the legal rulings.
18 On the same day, the Supreme Court also allowed the holdouts to pursue discovery against all of Argentina’s foreign
assets, not just those in the United States.
9
website that provides news coverage and analysis of the Supreme Court, had a “live blog”
of the announcements on June 16th, 2014. At 9:33am EST, SCOTUSBlog reported that
“Both of the Argentine bond cases have been denied. Sotomayor took no part” (Howe
(2014)). At 10:09am, the live blog stated that Argentina’s petition had been denied. At
10:11am, the live blog provided a link to the ruling. In figure 2, we plot the returns of the
Argentine ADRs and the five-year cumulative default probability, as measured by CDS. The
ADRs begin trading in New York at 9:30am. The default probability is constructed from
CDS spreads based on the Markit “sameday” data at 9:30am EST and 10:30am EST.

[ Insert figure 2 here ]

From 9:30am to 10:30am, the MSCI Argentina Index fell 6 percent and five-year cu-
mulative risk-neutral default probability rose by 9.8 percent. When the Argentine stock
market opened, the local stocks associated with the MSCI Argentina Index opened 6.2 per-
cent lower than it closed the previous night, implying virtually no change in the ADR-based
blue rate.

III. Framework and Results

In this section, we estimate the causal effect of sovereign default on equity returns us-
ing all of the events in our sample and two-day event windows. The key identification
concerns are that stock returns might have an effect on default probabilities, and that un-
observed common shocks might affect both the market-implied probability of default and
stock returns. In our context, one example of the former issue is that poor earnings by large
Argentine firms might harm the fiscal position of the Argentine government. An example of
the latter issue is a shock to the market price of risk, which could cause both CDS spreads
and stock returns to change.
We consider these issues through the lens of a simultaneous equation model (following
Rigobon and Sack (2004)). While our actual implementation uses multiple assets and con-
trols for various market factors, for exposition we discuss the log return of a single asset
(the equity index, for example), rt , and the change in the risk-neutral probability of default,
∆Dt , and ignore constants.19 The model we consider is

(1) ∆Dt = γrt + κD Ft + εt

(2) rt = α∆Dt + κFt + ηt

where Ft is a single unobserved factor that moves both the probability of default and equity
returns, εt is a shock to the default probability, ηt is a shock to the equity market return, and
all of these shocks are uncorrelated with each other and over time. The goal is to estimate
the parameter α, the impact of a change in the probability of default on equity market
returns.
Our key identifying assumption is that the information revealed to market participants
by the legal rulings affects firms’ stock returns only through the effect on the sovereign’s

19 In appendix Section I, we demonstrate how an equivalent system can be derived in a multi-asset framework.
10
risk-neutral probability of default. This assumption is equivalent to asserting that the legal
rulings are idiosyncratic default probability shocks (εt ) in the framework above. The as-
sumption embeds both the requirement that the legal rulings be exogenous (the εt shocks
are not correlated with the other shocks) and that the exclusion restriction is satisfied (the
εt shocks affect returns only by affecting default probabilities).
If one were to simply run the regression in equation (2) using OLS, the coefficient esti-
mate could be biased. There are two potential sources of bias: simultaneity bias (stock re-
turns affect default probabilities) and omitted variable bias (unobserved common factors).20
In order for the OLS regression to be unbiased, equity market returns must not affect de-
fault probabilities and there must be no omitted common shocks. These assumptions are
implausible in our context, but we present OLS results for comparison purposes.
We could rely on more plausible assumptions by adopting an event study framework (see,
for instance, Kuttner (2001) or Bernanke and Kuttner (2005)). In this case, the identifying
assumption would be that changes to Argentina’s risk-neutral probability of default during
the event windows (time periods in which a U.S. court makes a legal ruling) are driven
exclusively by those legal rulings, or other idiosyncratic default probability shocks (εt ).
Under this assumption, we could directly estimate equation (2) using OLS on these ruling
days. We present these results, and the details of the event studies, in appendix Section D.
Our preferred specification uses a heteroskedasticity-based identification strategy, fol-
lowing Rigobon (2003) and Rigobon and Sack (2004). This does not require the complete
absence of common and idiosyncratic shocks during event windows. This strategy instead
relies on the identifying assumption that the variances of the common shocks Ft and eq-
uity return shocks ηt are the same on non-event days and event days, whereas the variance
of the shock to the probability of default εt is higher on event days than non-event days
(because of the effects of the legal rulings, which we have assumed are εt shocks). Under
this assumption, we can identify the parameter α by comparing the covariance matrices of
abnormal returns and abnormal default probability changes on event days and non-event
days.
We divide all two-day periods in our sample into two types, events (E) and non-events
(N). For each of the two types of two-day windows, j ∈ {E, N} , we estimate the covariance
matrix of [rt , ∆Dt ] , denoted Ω j :
 
var j (rt ) cov j (rt , ∆Dt )
(3) Ωj =
cov j (rt , ∆Dt ) var j (∆Dt )

We can then define the difference in the covariance matrices during events and non-events
as ∆Ω = ΩE − ΩN , which simplifies to21
 2 
α α
(4) ∆Ω = λ
α 1

20 Rigobon and Sack (2004) discusses these biases in the context of this framework.
21 Algebraic details can be found in Rigobon (2003).
11
where
!
2 −σ2
σε,E ε,N
(5) λ= .
(1 − αγ)2

The estimator we employ, which we call the CDS-IV estimator, is defined as

∆Ω1,2 covE (∆Dt , rt ) − covN (∆Dt , rt )

(6) α̂CIV = =
∆Ω2,2 varE (∆Dt ) − varN (∆Dt )

As shown in Rigobon and Sack (2004), this estimator can be implemented in an instrumen-
tal variables framework. While at first glance there may appear to be alternative estimators
to estimate α based on ∆Ω, we believe they are not appropriate given our null hypothesis
that α = 0.22
The CDS-IV instrument is relevant under the assumption that λ > 0. We can reject
the hypothesis that λ = 0 using a test for equality of variances, which is described in ap-
pendix Section F. The relevance of the CDS-IV instrument is also suggested by the weak-
identification F-test of Stock and Yogo (2005), also reported in appendix Section F. In ta-
ble 2, we present the results of our CDS-IV estimation. The standard errors and confidence
intervals use the bootstrap procedure described in appendix Section C.
[ Insert table 2 ]

A. Equity Returns

In the first five columns of Table 2, we report the effects of increases in the probability of
default on different classes of Argentine equities. We focus on our preferred CDS-IV spec-
ification in the lower panel and report the OLS results in the upper panel for comparison
purposes. We find that a 10 percent increase in the five-year cumulative risk-neutral default
probability causes a negative 6.043 percent log-return for our value-weighted ADR index.
We also find that increases in the cumulative risk-neutral probability of default cause statis-
tically and economically significant declines in the MSCI Argentina Index, value-weighted
bank ADR index, value-weighted non-financial ADR index, and the YPF ADR. The MSCI
Argentina Index falls by substantially more than our value-weighted index because the
MSCI Argentina Index consists mostly of YPF and bank ADRs, which fall by more than
the ADRs of non-financial and real estate firms. We linearly extrapolate the log-return to
find that an increase in the risk-neutral default probability from 40 percent to 100 percent,
which is roughly what Argentina experienced, would cause around a 30 percent fall in the
value-weighted index, by our estimates. This increase also caused a 39 percent fall in the
value of banks, a 30 percent decline in non-financials, and a 43 percent fall for YPF, by our
estimates. Linearly extrapolating the log-return, we find that a completely unexpected de-
fault (a change from 0 percent to 100 percent in the risk-neutral default probability) would
cause a 45 percent fall in the value index. Our results are consistent with the hypothesis that
Argentina’s default caused significant harm to the value of Argentine firms.
22 These issues are discussed in more detail in appendix Section F.2.
12
 B. Exchange Rates

We next discuss our results for the various exchange rate measures we study. The last
four columns of Table 2 report our estimate of the effects of increases in the probability
of default on the four exchange rate measures. As with equities, we focus on the CDS-
IV results and report the OLS results for comparison. Unsurprisingly, given the Argentine
government’s exchange rate policy, we find no contemporaneous effect of increases in the
probability of default on the official exchange rate. We find that a 10 percent increase in the
risk-neutral probability of default causes a 1 percent depreciation in all three measures of
the parallel exchange rates. The results for the Dolar Blue (black market exchange rate) are
statistically significant; the results for the ADR blue rate and blue-chip swap rate are not.
In appendix Figure 3, we display the raw data behind these results. The ADR blue rate
and blue-chip swap results are both substantially influenced by a single outlier event (the
Supreme Court announcement described in section II.E). We discuss this outlier in appendix
Section A.3. For our other events, the ADR blue rate and blue-chip swap rate exhibit
a consistent pattern of depreciation during events in which the risk-neutral probability of
default increases, and appreciation during events in which that default probability decreases.
Our preferred interpretation of these results is that they are consistent with the empirical
coincidence of devaluation and default documented by Reinhart (2002), and with models
in which a government finds it optimal to simultaneously default and devalue, such as Na
et al. (2014). However, we must emphasize that the exchange rates we measure are not the
freely convertible exchange rates studied and modeled by those authors.

C. Magnitudes

In Table 3, we present estimates for the magnitude of the losses caused by default. The
columns labeled “Estimate (60 percent)” and “Estimate (100 percent)” report the estimated
losses caused by increasing the probability of default by 60 percent and 100 percent, respec-
tively. The 60 percent is relevant for Argentina because this is approximately the amount
the five-year risk-neutral default probability increased during the period of our study. The
100 percent column is relevant because it is closer to the concept of the cost of default in
the literature.
In the first three rows of the table, we present estimates for the firms that have ADRs.
The first-row estimates are calculated by multiplying the sum of the 2011 market values
of all non-YPF firms in the value index by the point estimate for the value index in Table
2, converted from log to arithmetic returns. The second-row estimates follow the same
procedure, for YPF, and the third row is the sum of the first two rows. The losses for firms
with ADRs are comparable to the ultimate cost of the 2016 settlement. In the fourth and
fifth rows, we also include the losses experienced by locally traded firms. We assume that
these firms experience losses at the same rate as the firms with ADRs. When considering
the losses on these two broader classes of firms, the direct reduction in the market value of
these firms as a result of default significantly exceeds the face value of all holdout claims.
For the firms with ADRs, including YPF, the average yearly earnings from the first quar-
13
ter of 2009 through the second quarter of 2011 was roughly $2.4 billion.23 We estimate that,
in response to a completely unanticipated default, the market value of these firms would de-
cline by roughly eight years of annual earnings. For reference, in the quantitative sovereign
debt model of Aguiar and Gopinath (2006), a country loses 2 percent of its output upon
default, and is “redeemed” with a 10 percent chance each quarter. If a firm’s ADR divi-
dends followed the same process after a default, the “cashflow news” (Campbell (1991))
associated with default would represent roughly 4—5 percent of the firm’s annual earnings.
Accounting for leverage explains part but not all of the difference (see appendix Section
G.3). One (speculative) explanation for our results is that default causes very persistent or
permanent output losses, or equivalently a decline in growth rates, and this is reflected in
firm earnings. This would be consistent with the findings of Gornemann (2014), who uses
a panel dataset to estimate the impact of default on growth rates. It would also be consistent
with the findings of Aguiar and Gopinath (2007), who argue that emerging market countries
experience shocks to their trend growth rate more generally.24 However, we must empha-
size that this is not the only possible explanation for our results, and that further research
on this topic is necessary.
[ Insert table 3 here ]

IV. Cross-Sectional Evidence

In this section, we examine which firm characteristics are associated with larger or smaller
responses to the default shocks. The cross-sectional pattern of responses across firms can
help shed light on the mechanism by which sovereign default affects the economy.
First, motivated by Bulow and Rogoff (1989a), we examine whether or not firms that are
reliant on exports are particularly hurt. Bulow and Rogoff (1989a) argue that in the event
of a sovereign default, foreign creditors can interfere with a country’s exports. Second,
motivated by Mendoza and Yue (2012), we examine whether or not firms that are reliant
on imported intermediate goods are particularly hurt by default. Mendoza and Yue (2012)
argue that a sovereign default reduces aggregate output because firms cannot secure financ-
ing to import goods needed for production, and so are forced to use domestic intermediate
goods, which are imperfect substitutes. Third, motivated by Bolton and Jeanne (2011),
Acharya, Drechsler and Schnabl (2014), Gennaioli, Martin and Rossi (2014), Perez (2014),
and Bocola (Forthcoming), we examine whether financial firms are more adversely affected.
While these papers are not explicitly about whether banks are hurt more than other firms,
they posit that the aggregate decline in output following a sovereign default occurs because
of the default’s effect on bank balance sheets. Finally, motivated by Cole and Kehoe (1998),
we examine whether foreign-owned firms underperform following an increase in the prob-
ability of sovereign default. Cole and Kehoe (1998) argue that “general reputation,” rather
23 We calculate annual earnings from 2009—2011 because of the availability of earnings data in CRSP for all of the firms
with ADRs. Unfortunately, that time period coincides with a recession in many developed countries. Using our preferred
measure of Argentine real GDP, growth was low but positive over this period.
24 The view that emerging market countries experience permanent productivity shocks is controversial (see, for example,
Garcı́a-Cicco, Pancrazi and Uribe (2010)).
14
than a specific reputation for repayment, is lost by defaulting on sovereign debt. This theory
would lead us to expect increases in the risk of sovereign default to cause foreign-owned
firms to underperform, due to a higher risk that Argentina will act disreputably in other
arenas, such as investment protection.
Our empirical approach is similar to several papers in the literature studying the cross
section of firms’ responses to identified monetary policy shocks, using an event study for
identification, such as Bernanke and Kuttner (2005) and Gorodnichenko and Weber (2016).
We test whether certain types of firms experience returns around our legal rulings that are
larger or smaller than would be expected, given those firms’ betas to the Argentine eq-
uity markets and exchange rate. In effect, we are testing whether the ensemble of shocks
that generate returns outside of the event windows have a similar cross-sectional pattern of
returns to the default probability shock.
Our procedures are motivated by a modified version of the model in equation (2) and
equation (1). We derive both models from a single underlying system of equations, pre-
sented in appendix Section I. The modified version of the those equations has the return of
the Argentine market index and the exchange rate on the right-hand side. We show that the
heteroskedasticity-based estimation procedure identifies the coefficient (αi − βiT αm ), where
αi is the response of this portfolio to the default shock, αm is the response of the market
index and exchange rate to the default shock, and βi are the coefficients of a regression of
the returns of portfolio i on the market index and ADR blue rate. This coefficient can be
interpreted as the excess sensitivity of the portfolio to the default shock, above and beyond
what would be expected from the Argentine equity market’s and exchange rate’s exposures
to the default shock, and the sensitivity of the portfolio to the Argentine equity market
and exchange rate. In this sense, our approach generalizes the CAPM-inspired analysis of
Bernanke and Kuttner (2005).
To increase our sample size of firms, we now use local Argentine stock returns, rather
than ADRs. The use of the local stocks and CDS data requires that both the New York and
Buenos Aires markets be open, which reduces the size of our sample. However, all but one
of the legal rulings remain in our sample.
We study which characteristics of firms are associated with over- or under-performance
in response to default shocks. We form zero-cost, long-short portfolios25 based on the
export intensity of their primary industry (for non-financial firms), the import intensity of
individual non-financial firms in 2007 and 2008 using data from Gopinath and Neiman
(2014), whether they are a listed subsidiary of a foreign firm, firm size, and whether they
have an associated ADR. For the exporter, importer, and firm size portfolios, we group firms
based on whether they are above or below the median value in our sample. An import-
intensive firm is not the opposite of an export-intensive one; some firms are classified as
neither import nor export intensive, whereas others are both import and export intensive.
In these portfolios, we equally weight firms within the “long” and “short” groups. For
example, we classify 12 of our 26 non-financial firms26 as high export intensity, and 14 of 26

25 Because we form long-short portfolios, the nominal exchange rate does not directly impact the portfolio’s return, except
to the extent that it differentially affects the firms.
26 We actually have 27 non-financial firms, but one is a technology firm. The technology firm’s industry classification did
not exist when the input/output table we use to construct the data was generated.
15
as low export intensity. We equally weight these firms, so that the “long” portfolio has a 1/12
weight on each high export intensity firm, and the short portfolio has a 1/14 weight on each
low export intensity firm. We then form the long-short portfolio, and determine whether
the portfolio over- or underperforms after a default shock, using the CDS-IV estimator and
bootstrapped confidence intervals discussed previously. The local equity index that we use
as a control is an equal-weighted index of all of the local stocks in our data sample. In
appendix Section G.4, we apply our CDS-IV estimator to the returns of the local stock
index, converted to dollars at the ADR blue rate.
The over- or underperformance of the portfolios is not an ideal test of the theories. For ex-
ample, if we do not observe that importing firms underperform, it may be because the firms
we observe are not the ones who would have difficulties, or because our import-intensive
and non-import-intensive firms also differ on some other characteristic that predicts over-
or underperformance (essentially an omitted variables problem). The reverse is also true;
a significant result does not necessarily validate the theory, but might instead be found be-
cause of a correlation across firms between importing and some other firm characteristic.
[Insert table 4 here]
In Table 4, we find that firms whose primary industry is export-intensive under-perform
given their exposure to the equal-weighted index and exchange rates, and those assets’
response to the default probability shock, while the long-short importer portfolio underper-
forms by a statistically insignificant amount.27 We find that foreign subsidiaries, of which
there are nine, underperform relative to non-financial firms that are not foreign subsidiaries.
This result is consistent with the general reputation theory of Cole and Kehoe (1998), which
implies that default makes policy changes more likely and that foreign investors become re-
luctant to invest. We also find that larger firms (defined as above-median market capitaliza-
tion in 2011) significantly underperform relative to smaller firms; however, this may reflect
the relative illiquidity of smaller firms’ stocks, rather than a difference in real outcomes.
We do not find that firms with an ADR substantially over- or underperform firms without
ADRs.
We estimate economically large, but not statistically significant, underperformance for
banks. The excessive sensitivity of bank stocks to default risk is consistent with the theo-
ries of Bolton and Jeanne (2011), Gennaioli, Martin and Rossi (2013, 2014), and Bocola
(Forthcoming). However, we find that a “de-levered” portfolio of bank stocks (see appendix
Section G.3) outperforms a de-levered portfolio of non-financial firms, which suggests that
the assets held by these Argentine banks are not substantially impaired by the sovereign
default. This result is not necessarily surprising—Argentina did not default on its local law,
locally owned debt.
We interpret this cross-sectional analysis as lending modest support to several of the
theories in the existing literature that try to understand the costs of sovereign default.

V. Identification and Interpretation

In this section, we discuss challenges to our identification assumption and alternative

interpretations of our stock market results, as well as the external validity of our results.
27 We display these results graphically in appendix Figure 4.
16
We first discuss the exogeneity of our shocks, and then discuss channels through which the
rulings might have affected firms, other than by changing the default probability.
We argue that the rulings of the courts are not influenced by news about the Argentine
economy. Formally, the interpretation of the laws in question does not depend on the state
of the Argentine economy. Substantively, because the amount required to repay the liti-
gating holdouts in full was small relative to the Argentine economy (more on this below),
news about the Argentine economy’s prospects would not materially change the Argentine
government’s ability to pay. Moreover, even if the judges were responding to economic fun-
damentals, under the null hypothesis that default does not affect fundamentals, the judges
would have no information advantage over market participants.28
It is important that our study avoid announcements by the Argentine government, because
such announcements might be responding to news about fundamentals, or affect corpora-
tions in ways other than through default. In the case of the Supreme Court decision dis-
cussed earlier, the Argentine government did not respond immediately to the ruling (Russo
and Porzecanski (2014)). More generally, we include as events only orders by a judge or
judges. We exclude orders that were issued during oral arguments, because those events
also include opportunities for lawyers representing Argentina to reveal information.
We also argue that the rulings did not directly impact the firms we study, except by
changing the probability of default. One potential issue is that the legal rulings might have
changed the probability or size of a settlement with the holdouts, and this could affect the
firms. To meet the precise demands of the courts, Argentina needed to pay its litigating cred-
itors only $1.5 billion. However, the $1.5 billion owed to the litigating creditors was only
around 10 percent of the estimated $15 billion holdout debt outstanding (Gelpern (2014a)).
Presumably, if Argentina paid NML and its co-litigants in full, the other holdout creditors
would have demanded repayment on similar terms; indeed, “me too” claims caused the size
of the 2016 settlement with litigating creditors to grow to $9.3 billion. Even if we assume
that Argentina will eventually need to pay the full $15 billion, that represented only 3 per-
cent of GDP, and 45 percent of foreign currency reserves, as of 2013.29 As seen in Table 3,
the actual repayment was less than the loss of market value experienced by publicly traded
firms. Because only a small fraction of Argentine firms are publicly traded, and there is no
reason to expect the tax burden to repay the debt to fall exclusively on these firms,30 the
direct repayment costs could only account for a tiny fraction of the loss of market value
experienced by these firms.
This issue is complicated, however, by the presence of a “Rights Upon Future Offers”
(RUFO) clause in the restructured bond contracts. If Argentina voluntarily made an offer to
the holdouts that was better than what the restructured creditors received, the restructured

28 More subtle interactions between the state of the Argentine economy and the legal rulings might complicate the interpre-
tation of our analysis. For example, if bad news about the Argentine economy causes the market response to the legal rulings
to be larger than it otherwise would have been, our estimates will reflect some sort of average effect, where the averaging
occurs over states of the economy.
29 The CIA World Factbook reports Argentina’s 2013 GDP as $484.6 billion, and its exchange and gold reserves at $33.7
billion as of December 31, 2013. However, the GDP calculation uses the official exchange rate, which may overstate the size
of Argentina’s economy.
30 Consistent with this argument, in past settlements (with the IMF and Paris club creditors), and in the eventual settlement
of the default in 2016, the costs of the settlement were paid out of general government revenues, funded in part by issuing
new government debt, and not borne by the particular firms we study.
17
creditors would be entitled to the better deal, provided the offer occurred before December
31, 2014. Argentina claimed that this RUFO clause meant that it could not pay NML the
$1.5 billion owed without incurring hundreds of billions in additional liabilities. There is
one crucial word in the RUFO that makes the whole matter more complicated: voluntarily.
If Argentina offered the holdouts a better deal because U.S. courts would otherwise have
blocked its payments to the restructured bondholders, would that offer be voluntary or in-
voluntary? Some observers noted that Argentina’s counsel told the Second Circuit Court of
Appeals that Argentina “would not voluntarily obey” court rulings to pay the holdouts in
full (Cotterill (2013)). In addition, other commenters noted that the RUFO clause appeared
to have some loopholes, allowing Argentina to potentially settle with the holdouts without
triggering the clause.31 Moreover, the restructured bondholders could waive their right to
exercise the RUFO clause, because it takes 25 percent of exchange bondholders to trigger
the clause, and the whole issue could have been rendered moot if the exchange bondholders
could be persuaded that waiving the clause was preferable to having their coupon payments
blocked. Of course, this possibility assumes Argentina would have paid any amount to the
holdouts, a questionable proposition given the domestic politics surrounding the holdouts
(Gelpern (2014b)). Notably, when the RUFO clause expired at the end of 2014, no progress
in settlement talks between the holdouts and Argentina was reported. Nevertheless, sup-
pose the RUFO clause was binding, and settlement with the holdouts was not possible. In
this case, the legal rulings caused Argentina to default, and our identification assumption
holds.32
Given our identification strategy, we would be concerned about any effect the rulings
had on the value of Argentine firms that did not operate through the rulings’ impact on
the probability of default. There is no direct effect on Argentine firms because they are
legally independent from the Argentine government, and their assets cannot be attached by
the holdouts.33 In fact, eleven of the twelve ADR firms issued debt internationally between
2002 and 2014, when the federal government of Argentina was excluded from international
debt markets.34 The ruling affects them only to the extent that it changes the behavior of
the Argentine government or other actors. One potential channel not operating through
the probability of default is the possibility that the legal rulings changed the law regarding
sovereign debt generally. We muster evidence against this in the appendix.35 Another
possible channel that would violate our exclusion restriction, which we cannot test, is that

31 See the comments from Barclay’s reported in Cotterill (2013).

32 If the RUFO clause was binding, and nevertheless a settlement was possible, one would have expected rulings in favor
of NML to raise the value of the restructured bonds. In fact, we observe that restructured bond prices decline along with
the stock returns. In appendix Section G.5, we report the effect of increases in the probability of default on the price of
the defaulted bonds held by the holdouts, the restructured bonds that Argentina eventually defaulted on in July 2014, and
domestic-law dollar debt.
33 There was litigation regarding whether the Argentine central bank qualified as independent from a legal perspective, but
no such litigation for any of the companies listed in the stock index.
34 Data from Bloomberg. The twelfth firm, Pampa Energia, issued debt internationally through a subsidiary.
35 In appendix Section G.1, we show that the stock markets of Brazil and Mexico and the risk-neutral default probabilities
of more than 30 countries did not respond to these legal rulings (our estimates are close to zero, and relatively precise). This
is in contrast to the OLS estimates, which show that those financial variables are correlated with the Argentine risk-neutral
probability of default, presumably due to common shocks affecting Latin America or emerging markets more generally. This
evidence suggests that, whatever changes to sovereign debt law occurred as the result of these rulings, they did not materially
impact other Latin American countries that issue debt in New York.
18
the rulings act as a sort of coordination device. For instance, the legal rulings could have
provoked the government of Argentina into a sequence of actions unrelated to sovereign
default, or changed the probability that the Peronist government of Argentina stayed in
power, for reasons unrelated to the default. It is important to remember, however, that
our costs of default are inclusive of the effects on government policy changes and political
fortunes, if these changes occur because of the default. Our exclusion restriction is only
violated if these changes are unrelated to sovereign default.

A. Interpreting Returns

In this subsection, we discuss how to interpret the stock returns and risk-neutral default
probability changes we study. First, we argue that U.S. investors’ stochastic discount fac-
tor is the relevant one for pricing the ADRs and CDS. As shown by Edison and Warnock
(2004), the ADRs we study are held by U.S. investors in proportion to their market weight,
and are not affected by “home bias.” In appendix Section H.1, we document that the ADRs
we study are held by large, diversified financial institutions (who are also the type of institu-
tions that trade CDS). In appendix Section H.2, we show that the average turnover of ADRs
is significantly higher than the average turnover of the underlying local equities, providing
further evidence for the relative importance of foreign investors in pricing Argentine firms.
Second, we argue that the stock returns and risk-neutral default probability changes we
study measure Argentina-specific news. The legal shocks are an almost canonical example
of idiosyncratic risk, and it is very unlikely that U.S. investors’ stochastic discount factor
is meaningfully affected by these legal rulings. Consistent with this argument, we find no
evidence for an impact of these rulings on other emerging market CDS spreads and stock
indices (see appendix Section G.1). We also control for the legal rulings’ impact on a
variety of proxies for the price of risk. Consistent with the previous point, incorporating
these controls makes little difference for our estimates.
However, it is possible that these legal rulings create a shortage of Argentina-specific (as
opposed to emerging-market specific) expert capital, along the lines of Gabaix and Maggiori
(2015). We muster evidence against this by showing that Argentine-listed multinationals,
such as Tenaris and Petrobras Brazil are unaffected by the default shocks (see table 11 in
the appendix). This expert-specific capital would therefore have to defined more narrowly
than firms trading on the Buenos Aires Stock Exchange, and this shortage of expert capital
would have to occur within the large financial institutions that own the ADRs we study.
Assuming the shocks we study are Argentina-specific news, there are two potential (and
not exclusive) explanations for these returns. The most direct interpretation is that the re-
turns represent changes in the expected cash flows from the ADRs. Alternatively, the returns
could be caused by an increase in the exposure of the dividends of the ADRs to priced risk
factors (an increase in “beta,” rather than a change in the mean value of the dividends). This
would explain a decline in the value of the firms, as valued by the market. If the returns we
measure are caused by this discount rate news, then we should expect that our legal rulings
predict future returns. We have run our heteroskedasticity-based estimator using two-day-
ahead returns, rather than contemporaneous returns, as the outcome variable. We found no
significant effects, but our standard errors are too large to rule out economically plausible
return predictability. Additionally, for some purposes, it may not matter whether the value
19
of Argentine firms fell because they were expected to be less profitable as a result of the
default or because they became riskier as a result of the default.
The issues discussed in this section with regards to stock returns also apply with regards
to the risk-neutral probability of default, as measured by credit default swaps. The most
straightforward interpretation of the changes in default probabilities we study is that they
are changes in the physical default probability. However, it is theoretically possible that the
legal rulings induced changes in the covariance between Argentine default or recovery rates
and priced risk factors, and this caused part of the change in risk-neutral probabilities that
we observe.
One concern we can muster evidence against is that Argentine CDS markets are thinly
traded. According to data from the Depository Trust and Clearing Corporate (DTCC), from
the first quarter of 2011 until the second quarter of 2014, the Argentine sovereign was the
15th most commonly traded sovereign CDS and the 48th most commonly single-name CDS
overall. In appendix Section H.3, we compare the liquidity of Argentine sovereign CDS to
the liquidity of CDS on other emerging market governments, major financial institutions,
and non-financial corporations.
Even if we assume that the negative returns we observe represent cashflow news, there is
still the question of whether news about these ADRs is representative of Argentina’s broader
economy. Ideally, we would study the returns of assets whose cashflows exactly matched
Argentine GDP.36 However, as mentioned previously, the earnings of firms with ADRs are
a small fraction of the Argentine economy. Market participants may have anticipated that,
conditional on default, it would become difficult for firms to make payments on their ADR
dividends. In other words, default might have caused the government to adjust its capital
controls.
Ex-post, we know that this did not occur, and we are not aware of any evidence suggesting
it was ever likely. However, suppose investors were concerned about this possibility. In
this case, we might expect to see a significant difference between firms’ local (peso) stock
performance and their ADR performance. However, to compare the performance of local
stocks and ADRs, we need a measure of the exchange rate that would not be affected by
these capital controls. Unfortunately, all of our market exchange rate measures (the ADR
blue, the blue-chip swap, and the Dolar Blue) would likely be affected by changes in the
capital control regime. We do not find any evidence that there is a different effect across
these three exchange rates. This suggests that, if changes in capital controls conditional
on default were anticipated, the anticipated changes would have applied equally to bonds,
stocks, and other means by which Argentines can acquire dollars.

B. External Validity

Our estimates of the cost of default include the consequences of whatever policies the
government is expected to employ, conditional on default. These costs also include the
effects of firms, households, and other agents changing their behavior as a result of the

36 In fact, Argentina has issued real GDP warrants. However, they are very illiquid, have option-like features, may have
been “pari passu” with the holdout’s debt claims, and are affected by the measurement of Argentine inflation. In Section G.6
of the appendix, we discuss these issues and present results for the GDP warrants.
20
default. For the government, these policies could include renegotiating with creditors, find-
ing other means to borrow, balancing budgets via taxes or reduced spending, and taking
actions that affect the convertibility of the currency, among other actions. When we refer
to the causal of effects of sovereign default, we include the anticipated effects of whatever
policies the government is expected to employ as a result of having defaulted. The exter-
nal validity of our results depends on the extent to which other defaulting countries would
behave similarly to Argentina in the aftermath of a default.
One potential cost of default is exclusion from markets. Although the debt exchanges
of 2005 and 2010 eventually achieved a participation rate of 91.3 percent—above the level
generally needed by a sovereign to resolve a default and reenter capital markets—the gov-
ernment of Argentina remained unable to issue international law bonds. Ongoing creditor
litigation had resulted in an attachment order, which would allow the holdouts to confiscate
the proceeds from any new bond issuance (Hornbeck (2013)). However, prior to these le-
gal rulings, the government of Argentina was able to issue local-law, dollar-denominated
bonds, and some of those bonds were purchased by foreigners. Some of these local-law
bonds were affected by the legal rulings, and it may have become more difficult for Ar-
gentina to borrow as a result of the rulings.
There are several complications arising from Argentina’s ambiguous international stand-
ing. If the costs of default for Argentina were lower than that of a typical sovereign debtor,
because Argentina was already unable to borrow in international markets, then our esti-
mates understate the costs for the typical sovereign. On the other hand, because Argentina
chose to default despite an ability to pay, the costs might be higher than is typical. These
complications emphasize the uniqueness of Argentina’s circumstances.

VI. Conclusion

For several decades, one of the most important questions in international macroeco-
nomics has been “why do governments repay their debts?” Using an identification strat-
egy that exploits the timing of legal rulings in the case of Republic of Argentina v. NML
Capital, we present evidence that a sovereign default significantly reduces the value of do-
mestic firms. We provide suggestive evidence that exporters and foreign-owned firms are
particularly hurt by sovereign default.

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VIII. Tables and Figures

Table 1—: Summary Statistics

Window Type Event Non-Event
Mean ∆Dt (percent) -0.09 -0.01
SD ∆Dt (percent) 5.06 1.79
Mean Equity Log Return (percent) 0.30 0.04
Equity Log Return SD (percent) 4.02 2.77
Cov(∆Dt , rt ) -15.27 -2.21
Number of two-day windows 15 386
Notes: This table reports the mean default probability change, the standard deviation of default probability
changes, the mean value-weighted index return, the standard deviation of that return, and the covariance of
default probability changes and that return during events and non-events. The underlying data is based on the
two-day event windows and non-events described in the text.

23
 Table 2—: Equity and Exchange Rate Results
(1) (2) (3) (4) (5) (6) (7) (8) (9)
MSCI Value Bank Non-Fin. YPF Official Dolar Blue ADR Blue BCS
OLS
∆D -50.44 -42.35 -53.89 -41.32 -55.13 4.183 9.689 20.91 24.72
SE (9.641) (7.165) (8.829) (8.192) (16.91) (3.540) (3.994) (6.366) (6.316)
95 percent CI [-70.5,-30.6] [-58.4,-27.3] [-72.7,-36.1] [-59.6,-24.3] [-88.5,-15.8] [-39.3,9.3] [2.0,17.3] [8.9,37.7] [13.2,40.1]
CDS-IV
∆D -79.44 -60.43 -83.16 -58.63 -93.69 -0.716 10.37 10.71 11.01
SE (16.20) (13.25) (12.91) (19.76) (22.09) (1.430) (3.325) (15.95) (18.02)
95 percent CI [-110.3,-41.0] [-89.4,-36.2] [-112.2,-61.0] [-103.4,-9.2] [-141.1,-39.1] [-3.2,1.9] [3.0,17.0] [-29.4,86.6] [-33.3,106.1]

24
Events 15 15 15 15 15 15 14 14 14
Obs. 401 401 401 401 401 401 355 353 356
Notes: This table reports the results for the OLS and CDS-IV estimators of the effect of changes in the risk-neutral default probability (∆D) on several equity
indices and exchange rates. The equity indices are the MSCI Index, the Value-Weighted index, the Value-Weighted Bank Index, the Value-Weighted
Non-Financial Index, and YPF. All indices are composed of ADRs. The index weighting is described in the text. For exchange rates, Official is the government’s
official exchange rate. Dolar Blue is the onshore unofficial exchange rate from dolarblue.net. ADR Blue is the ADR Blue Rate constructed by comparing the
ADR share price in dollars with the underlying local stock price in pesos, as described in Section II. BCS is the Blue-Chip Swap as constructed by comparing
the ARS price of domestic Argentine sovereign debt with the dollar price of the same bond, as described in Section II. The coefficient on ∆D is the effect on the
percentage log returns of an increase in the five-year risk-neutral default probability from 0 percent to 100 percent, implied by the Argentine CDS curve.
Standard errors and confidence intervals are computed using the stratified bootstrap procedure described in the text. The underlying data is based on the two-day
event windows and non-events described in the appendix. All regressions contain controls for VIX, S&P, EEMA, high-yield and investment-grade bond indices,
and oil prices.
 Table 3—: Magnitudes
Measure Estimate (60 percent) Estimate (100 percent)
ADRs (ex. YPF) -4.7 $B -7.9 $B
YPF -6.6 $B -11.0 $B
ADRs -11.3 $B -18.9 $B
All equities in dataset -15.6 $B -26.0 $B
All equities -16.7 $B -27.8 $B
Actual Repayment 12.5 $B (Estimated)
Notes: The first line, “ADRs (ex.YPF)” reports the imputed loss of market value all firms included in our
sample of ADRs experienced, excluding YPF. It is calculated by multiplying the sum of the market values of
all the firms in 2011 by point estimate on the Value Index in Table 2. The second row, “YPF,” reports the same
calculation for YPF. The third row, “ADRs,” is the sum of the first two. The fourth row, “All equities in
dataset,” is the loss by locally traded firms that are included in the analysis of Section IV. It is computed by
extrapolating the losses of the value index to these stocks. The fifth row, “All equities,” includes all Argentine
firms with listed equities, even those that do not meet the data quality standards to be included in Section IV,
and is also computed by extrapolation. “Actual Repayment” is the cost to the government of Argentina of the
recently agreed-upon settlement with the major holdouts, extrapolated to cover all holdouts.

25
 Table 4—: Cross Section: Long-Short Portfolios, CDS-IV
(1) (2) (3) (4) (5) (6)
Foreign Financial Exporter Importer Size ADR
∆D -27.96 -34.36 -39.47 -6.199 -33.72 -12.81
(9.538) (16.51) (9.867) (8.350) (10.20) (12.46)
95 percent CI [-51.0,-10.1] [-78.2,13.7] [-62.8,-20.6] [-24.7,12.5] [-56.9,-9.8] [-46.9,23.4]
Index β -0.341 0.0198 -0.682 -0.169 -0.396 0.0679
FX β -0.0888 -0.0252 -0.351 -0.141 0.0497 0.139
Events 14 14 14 14 14 14
Obs. 353 353 353 353 353 353
Notes: This table reports the results for the “CDS-IV” estimator. The column headings denote the outcome
variable, a zero-cost long short portfolio. “Foreign” goes long firms with a foreign parent and short
domestically owned firms. “Financial” goes long banks and short non-financial firms. “Exporter” goes long
export-intensive non-financial firms and short non-export-intensive non-financial firms. “Importer” is defined
equivalently for importers. “Size” goes long firms with above-median market capitalization in 2011, and short
firms with below-median market cap. “ADR” goes long firms with an American Depository Receipt and short
firms without one. The coefficient on ∆D is the effect on the percentage log returns of an increase in the
five-year risk-neutral default probability from 0 percent to 100 percent, implied by the Argentine CDS curve.
Index beta is the coefficient on the equal-weighted index of Argentine local equities, as described in Section
IV, and FX beta is the beta to the ADR blue rate. Standard errors and confidence intervals are computed using
the stratified bootstrap procedure described in appendix Section C. The underlying data is based on the
two-day event windows and non-events described in the text. All regressions contain controls for VIX, S&P,
EEMA, high-yield and investment-grade bond indices, and oil prices.

26
 Figure 1. : Exchange Rates

14
1210
ARS/USD
8 6
4

2011 2012 2013 2014

Official Dolar Blue

ADR Blue Chip Swap

Notes: This figure plots the four versions of the ARS/USD exchange rate. Official is the government’s official
exchange rate. Dolar Blue is the onshore unofficial exchange rate from dolarblue.net. ADR is the ADR Blue
Rate constructed by comparing the ADR share price in dollars with the underlying local stock price in pesos,
as described in Section II. Blue-Chip Swap is constructed by comparing the ARS price of domestic Argentine
sovereign debt with the dollar price of the same bond, as described in Section II.

Figure 2. : Event Data from June 16, 2014, 9:30–11:30am EST

76

London
0
Equity Log Return Since Close (Percent)
−2
Probability of Default (Percent)
74

−4
72

−6
70

−8
68

−10

Europe
66

9:30 am 10:30 am 11:30 am

Probability of Default MSCI Argentina Index

Notes: This figure plots the five-year risk-neutral probability of default (“Probability of Default (Percent),” left
axis), the change in the price of the MSCI Argentina Index against the previous night’s close (“Equity Return
Since Close (Percent),” right axis). The default probability points are labeled with the name of the reporting
market, with European markets reporting at 9:30am EST and London Markets reporting at 10:30am EST. The
Supreme Court order was released at 9:33 am EST.

27
 Figure 3. : Equity Returns and Argentine Default Probability
(a) Argentine Equity Index

10 6
2
5

1
3 14 10
Log Return

4 5
0

12
7
9 15
8
11
−5

13
−10
−15

−10 −5 0 5 10
Change in Default Probability

Non−Event Event

(b) Mexican Equity Index

10
5

7
12
Log Return

4
2 5
3 14
0

6 11 1 15 13
9 8
10
−5
−10

−10 −5 0 5 10
Change in Default Probability

Non−Event Event

Notes: This figure plots the change in the risk-neutral probability of default and returns on the Argentine
value-weighted Index (top panel) and MSCI Mexico Index (bottom panel) on event and non-event two-day
windows. Each event and non-event window is a two-day event or non-event as described in the text. The
numbers next to each maroon/dark/large dot reference an event window in appendix Table 19. The procedure
for classifying events and non-events is described in the text.

28