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Sovereign risk contagion

Author: Cristina Arellano; Yan Bai; Sandra V Lizarazo; National Bureau of Economic Research,
Publisher: Cambridge, Mass. : National Bureau of Economic Research, 2017.
Series: Working paper series (National Bureau of Economic Research), no. 24031.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
We develop a theory of sovereign risk contagion based on financial links. In our multi-country model, sovereign bond spreads comove because default in one country can trigger default in other countries. Countries are linked because they borrow, default, and renegotiate with common lenders, and the bond price and recovery schedules for each country depend on the choices of other countries. A foreign default increases  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Cristina Arellano; Yan Bai; Sandra V Lizarazo; National Bureau of Economic Research,
OCLC Number: 1013474733
Notes: "November 2017."
Description: 1 online resource (49 pages) : illustrations
Series Title: Working paper series (National Bureau of Economic Research), no. 24031.
Responsibility: Cristina Arellano, Yan Bai, Sandra Lizarazo.

Abstract:

We develop a theory of sovereign risk contagion based on financial links. In our multi-country model, sovereign bond spreads comove because default in one country can trigger default in other countries. Countries are linked because they borrow, default, and renegotiate with common lenders, and the bond price and recovery schedules for each country depend on the choices of other countries. A foreign default increases the lenders' pricing kernel, which makes home borrowing more expensive and can induce a home default. Countries also default together because by doing so they can renegotiate the debt simultaneously and pay lower recoveries. We apply our model to the 2012 debt crises of Italy and Spain and show that it can replicate the time path of spreads during the crises. In a counterfactual exercise, we find that the debt crisis in Spain (Italy) can account for one-half (one-third) of the increase in the bond spreads of Italy (Spain).

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