Sovereign default risk, overconfident investors and diverse beliefs: Theory and evidence from a new dataset on outstanding credit default swaps

Thorsten Janus, Yothin Jinjarak and Manachaya Uruyos

Journal of Financial Stability, 2013, vol. 9, issue 3, 330-336

Abstract: In standard public finance theory a government's cost of borrowing depends on the common beliefs held by rational investors regarding default risk. We advance understanding of the effects of diverse beliefs and overconfidence among investors in their ability to assess the sovereign's creditworthiness. Theoretically, we find that demand for insurance against default is positively related to the absolute difference between the market price of sovereign risk and the risk forecasted by the economy's fundamentals. We find preliminary support for this prediction in a newly available dataset on sovereign credit default swaps (CDSs): after controlling for the size of the public debt, the absolute size of the gap between the actual and forecasted spreads is positively related to the value of outstanding CDSs.

Keywords: Public debt; Fiscal capacity; Sovereign default; Market expectation (search for similar items in EconPapers)
JEL-codes: E6 F4 H6 O1 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S1572308912000708
Full text for ScienceDirect subscribers only

Related works:
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:finsta:v:9:y:2013:i:3:p:330-336

DOI: 10.1016/j.jfs.2012.11.007

Access Statistics for this article

Journal of Financial Stability is currently edited by I. Hasan, W. C. Hunter and G. G. Kaufman

More articles in Journal of Financial Stability from Elsevier
Bibliographic data for series maintained by Catherine Liu ().