Three sisters: The interlinkage between sovereign debt, currency, and banking crises

Abstract

This study analyzes the interlinkage between sovereign debt, currency, and banking crises by applying panel data probit and multivariate probit models to a sample of 21 emerging economies observed monthly between 1985 and 2020. The results establish the simultaneity of the three crises in a given month, where banking, sovereign debt, and currency crises tend to occur jointly caused by common unobservable factors. The results also indicate that banking crises usually precede sovereign defaults, but not vice versa. Indirect effects suggest that short-term external indebtedness during banking crises, and misaligned exchange rates corrected by currency crises increase the future sovereign default likelihood.