The paper analyses the drivers of sovereign risk for 31 advanced and emerging economies during the European sovereign debt crisis. It shows that a deterioration in countries' fundamentals and ...fundamentals contagion – a sharp rise in the sensitivity of financial markets to fundamentals – are the main explanations for the rise in sovereign yield spreads and CDS spreads during the crisis, not only for euro area countries but globally. By contrast, regional spillovers and contagion have been less important, including for euro area countries. The paper also finds evidence for herding contagion – sharp, simultaneous increases in sovereign yields across countries – but this contagion has been concentrated in time and among a few markets. Finally, empirical models with economic fundamentals generally do a poor job in explaining sovereign risk in the pre-crisis period for European economies, suggesting that the market pricing of sovereign risk may not have been fully reflecting fundamentals prior to the crisis.
How high can public debt rise without compromising fiscal solvency? We answer this question using a stochastic model of sovereign default in which risk-neutral investors lend to a government that ...displays 'fiscal fatigue', whereby its ability to increase primary balances cannot keep pace with rising debt. As a result, the government faces an endogenous debt limit beyond which debt cannot be rolled over. Using data for 23 advanced economies over the period 1970—2007, we find evidence of a fiscal reaction function with these features, and use it to compute 'fiscal space', defined as the difference between current debt ratios and the estimated debt limits.
Why Not Default? Roos, Jerome E
2019, 20190212, 2019-02-12
eBook
How creditors came to wield unprecedented power over heavily indebted countries-and the dangers this poses to democracy
The European debt crisis has rekindled long-standing debates about the power of ...finance and the fraught relationship between capitalism and democracy in a globalized world.Why Not Default?unravels a striking puzzle at the heart of these debates-why, despite frequent crises and the immense costs of repayment, do so many heavily indebted countries continue to service their international debts?
In this compelling and incisive book, Jerome Roos provides a sweeping investigation of the political economy of sovereign debt and international crisis management. He takes readers from the rise of public borrowing in the Italian city-states to the gunboat diplomacy of the imperialist era and the wave of sovereign defaults during the Great Depression. He vividly describes the debt crises of developing countries in the 1980s and 1990s and sheds new light on the recent turmoil inside the Eurozone-including the dramatic capitulation of Greece's short-lived anti-austerity government to its European creditors in 2015.
Drawing on in-depth case studies of contemporary debt crises in Mexico, Argentina, and Greece,Why Not Default?paints a disconcerting picture of the ascendancy of global finance. This important book shows how the profound transformation of the capitalist world economy over the past four decades has endowed private and official creditors with unprecedented structural power over heavily indebted borrowers, enabling them to impose painful austerity measures and enforce uninterrupted debt service during times of crisis-with devastating social consequences and far-reaching implications for democracy.
•We examine the impact of economic policy uncertainty on risk spillovers within the Euro-zone.•We adapt the method developed by Adrian and Brunnermeier (forthcoming) to measure sovereign bond's risk ...spillovers.•We use a panel data model with economic policy uncertainty indices proposed by Baker et al. (2013) as regressors.•Economic policy uncertainty has an impact on country-level risk spillovers.•The impact of economic policy uncertainty on risk spillover is stronger for “leading” countries such as Germany.
This paper focuses on the impact of economic policy uncertainty on risk spillovers within the Eurozone and contributes to these two growing literatures. To this end, we adapt the two-step procedure developed by Adrian and Brunnermeier (forthcoming) in the framework of financial systemic risk to the sovereign bond market. Accordingly, we attempt (i) to measure the extent to which distress affecting one given country's sovereign spreads can affect the Eurozone's bond market as a whole and then (ii) to identify the determinants of risk spillovers by estimating a panel data model with macroeconomic state variables and economic policy uncertainty (EPU) indices introduced by Baker et al. (2013) as regressors. EPU indices considered concern the four largest Eurozone countries, i.e. Germany, France, Italy and Spain, as well as the United States. The model is estimated with quarterly data for ten countries representing the bulk of debt issuances within the Eurozone over a period ranging from Q4/2008 to Q2/2013, which is characterized by historically high dispersion of sovereign bond spreads either across time or across countries. Our results support the idea that economic policy uncertainty in the core economies of the Eurozone, i.e. Germany and France, as well as in the largest periphery countries, i.e. Italy and Spain, can create an environment likely to exacerbate the transmission of risk arising from abnormal developments of individual countries' sovereign spreads to the Eurozone bond market as a whole. In this respect, our results plead for larger effort of Eurozone “leaders” to reduce the uncertainty surrounding their economic policy in periods of crisis not only to avoid adverse effects on their own economies but also to reduce the risk of a destabilization of the Eurozone sovereign bond market as a whole.
This paper investigates contagion between bank and sovereign default risk in Europe over the period 2007–2012. We define contagion as excess correlation, i.e. correlation between banks and sovereigns ...over and above what is explained by common factors, using CDS spreads at the bank and at the sovereign level. Moreover, we investigate the determinants of contagion by analyzing bank-specific as well as country-specific variables and their interaction. Using the EBA’s disclosure of sovereign exposures of banks, we provide empirical evidence that three contagion channels are at work: a guarantee channel, an asset holdings channel and a collateral channel. We find that banks with a weak capital buffer, a weak funding structure and less traditional banking activities are particularly vulnerable to risk spillovers. At the country level, the debt ratio is the most important driver of contagion. Furthermore, the impact of government interventions on contagion depends on the type of intervention, with outright capital injections being the most effective measure in reducing spillover intensity.
We study how crises affect Central Clearing Counterparties (CCPs). We focus on a large and safe segment of the CCP-cleared repo market during the Eurozone sovereign debt crisis. We develop a simple ...model to infer CCP stress, which is measured as repo rates’ sensitivity to sovereign credit default swaps (CDS) spreads and jointly captures (1) the effectiveness of haircut policies, (2) CCP-member default risk (conditional on sovereign default), and (3) CCP default risk (conditional on both sovereign and CCP-member default). During 2011, repo rates strongly respond to sovereign risk, particularly for Greece, Italy, Ireland, Portugal and Spain (GIIPS): Repo investors behaved as if the conditional probability of CCP default was substantial.
Deadly Embrace FARHI, EMMANUEL; TIROLE, JEAN
The Review of economic studies,
07/2018, Letnik:
85, Številka:
3 (304)
Journal Article
Recenzirano
Odprti dostop
The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency. This article provides a theory of the feedback loop that ...allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. Our theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.
This article analyses the impact of strained government finances on macroeconomic stability and the transmission of fiscal policy. Using a variant of the model by Cúrdia and Woodford (2009), we study ...a 'sovereign risk channel' through which sovereign default risk raises funding costs in the private sector. If monetary policy cannot offset increased credit spreads because it is constrained by the zero lower bound or otherwise, the sovereign risk channel exacerbates indeterminacy problems: private-sector beliefs of a weakening economy may become self-fulfilling. In addition, sovereign risk may amplify the effects of cyclical shocks. Under those conditions, fiscal retrenchment can help curtail the risk of macroeconomic instability and, in extreme cases, even bolster economic activity.
International Reserves and Rollover Risk Bianchi, Javier; Hatchondo, Juan Carlos; Martinez, Leonardo
The American economic review,
09/2018, Letnik:
108, Številka:
9
Journal Article
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We study the optimal accumulation of international reserves in a quantitative model of sovereign default with long-term debt and a risk-free asset. Keeping higher levels of reserves provides a hedge ...against rollover risk, but this is costly because using reserves to pay down debt allows the government to reduce sovereign spreads. Our model, parameterized to mimic salient features of a typical emerging economy, can account for significant holdings of international reserves, and the larger accumulation of both debt and reserves in periods of low spreads and high income. We also show that income windfalls, improved policy frameworks, and an increase in the importance of rollover risk imply increases in the optimal holdings of reserves that are consistent with the upward trend in reserves in emerging economies. It is essential for our results that debt maturity exceeds one period.
A Model of Safe Asset Determination He, Zhiguo; Krishnamurthy, Arvind; Milbradt, Konstantin
The American economic review,
04/2019, Letnik:
109, Številka:
4
Journal Article
Recenzirano
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What makes an asset a “safe” asset? We study a model where two countries each issue sovereign bonds to satisfy investors’ safe asset demands. The countries differ in the float of their bonds and the ...fundamental resources available to rollover debts. A sovereign’s debt is safer if its fundamentals are strong relative to other possible safe assets, not merely strong on an absolute basis. If demand for safe assets is high, a large float enhances safety through a market depth benefit. If demand for safe assets is low, then large debt size is a negative as rollover risk looms large.
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