Sovereign Default and Coalition Formation

Strong evidence has shown that the likelihood of sovereign debt default and rescheduling in democratic developing countries is smaller when the government is composed by more than one political party. The frequency of surplus coalitions in both developing and developed countries seems to contradict the theory of the minimal winning coalition. This paper links sovereign default empirical evidence with coalition formation theory. It provides a formal explanation for the coalition effect in the default probability, and for the formation of surplus coalitions. Two parties rotate in power, and they may form a coalition with a smaller party, which is directly interested in sovereign debt repayment. Its presence in the cabinet leads to higher bond prices. When the effect of higher bond price dominates the redistributive effect of one more party in government, bigger political parties form coalitions, even when this is not necessary to guarantee majority support in the legislative.