What is the risk of European sovereign debt defaults? Fiscal space, CDS spreads and market pricing of risk

Joshua Aizenman, Michael Hutchison and Yothin Jinjarak

Journal of International Money and Finance, 2013, vol. 34, issue C, 37-59

Abstract: We estimate the pricing of sovereign risk for fifty countries based on fiscal space (debt/tax; deficits/tax) and other economic fundamentals over 2005–10. We focus in particular on five countries in the South-West Eurozone Periphery, Greece, Ireland, Italy, Portugal and Spain. Dynamic panel estimates show that fiscal space and other macroeconomic factors are statistically and economically important determinants of sovereign risk. However, risk-pricing of the Eurozone Periphery countries is not predicted accurately either in-sample or out-of-sample: unpredicted high spreads are evident during global crisis period, especially in 2010 when the sovereign debt crisis swept over the periphery area. We match the periphery group with five middle income countries outside Europe that were closest in terms of fiscal space during the European fiscal crisis. Eurozone Periphery default risk is priced much higher than the matched countries in 2010, even allowing for differences in fundamentals. One interpretation is that these economies switched to a “pessimistic” self-fulfilling expectational equilibrium. An alternative interpretation is that the market prices not on current but future fundamentals, expecting adjustment challenges in the Eurozone periphery to be more difficult for than the matched group of middle-income countries because of exchange rate and monetary constraints.

Keywords: CDS spreads; Sovereign risk; Fiscal space; Default risk; Eurozone (search for similar items in EconPapers)
JEL-codes: E43 F30 G01 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (262)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0261560612001908
Full text for ScienceDirect subscribers only

Related works:
Working Paper: What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk (2011)
Working Paper: What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk (2011)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:34:y:2013:i:c:p:37-59

DOI: 10.1016/j.jimonfin.2012.11.011

Access Statistics for this article

Journal of International Money and Finance is currently edited by J. R. Lothian

More articles in Journal of International Money and Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().