Inelastic Demand Meets Optimal Supply of Risky Sovereign Bonds

Matías Moretti (), Lorenzo Pandolfi (), Sergio Schmukler, Germán Villegas Bauer () and Tomas Williams
Additional contact information
Matías Moretti: University of Rochester
Lorenzo Pandolfi: Università di Napoli Federico II and CSEF, https://csef.it/people/lorenzo-pandolfi/
Germán Villegas Bauer: International Monetary Fund

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: We present evidence of inelastic demand in the market for risky sovereign bonds and examine how it affects government policies. We exploit monthly changes in the composition of a major emerging market bond index to identify flow shocks that shift the available bond supply, which are unrelated to country fundamentals. Our estimates imply an average inverse price demand elasticity of -0.30, higher in magnitude than estimates for advanced economies. This elasticity increases with default risk, suggesting that investors demand a premium as compensation for risk. We develop a sovereign debt model with endogenous default, and we discipline it based on our empirical estimates. Under inelastic investors, an additional unit of debt lowers bond prices even under constant default risk. Because governments internalize this effect, the inelastic demand becomes a commitment device that limits debt issuances. Our quantitative model shows that this mechanism significantly reduces default risk and bond spreads.

Keywords: einelastic financial markets; institutional investors; international capital markets; sovereign debt (search for similar items in EconPapers)
JEL-codes: F34 F41 G11 G15 (search for similar items in EconPapers)
Date: 2024-03-26, Revised 2024-10-01
New Economics Papers: this item is included in nep-dge, nep-fmk, nep-ifn and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.csef.it/WP/wp713.pdf (application/pdf)

Related works:
Working Paper: Inelastic Demand Meets Optimal Supply of Risky Sovereign Bonds (2024)
Working Paper: Inelastic Demand Meets Optimal Supply of Risky Sovereign Bonds (2024)
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:sef:csefwp:713

Access Statistics for this paper

More papers in CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy Contact information at EDIRC.
Bibliographic data for series maintained by Dr. Maria Carannante ().