Default risk is the chance that a borrower cannot or will not pay back what they owe. Every loan, bond, and credit arrangement carries some default risk. US Treasury bonds have near-zero default risk; a startup's bonds might have 20%+ default probability. The higher the default risk, the higher the interest rate a borrower must pay.
Credit rating agencies quantify default risk: AAA-rated bonds have a 0.01% historical default rate; B-rated bonds default at 4-5% annually. The credit spread — the extra yield investors demand over risk-free Treasuries — reflects perceived default risk. During the 2008 crisis, credit spreads on junk bonds widened to over 20%, as investors panicked about widespread defaults.
Sovereign default is rare but devastating. Sri Lanka defaulted on its foreign debt in 2022; Russia defaulted the same year due to sanctions. Argentina defaulted in 2020 — its ninth sovereign default. For corporate bonds, default recovery rates average 40 cents on the dollar — meaning bondholders typically lose 60% when a company defaults.