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Sovereigns at risk: A dynamic model of sovereign debt and banking leverage

Nuno Coimbra

Journal of International Economics, 2020, vol. 124, issue C

Abstract: This paper develops a dynamic model with heterogeneous investors and sovereign default to analyze the dynamic link between banking sector capitalization and sovereign bond yields. The banking sector is modelled as operating under a Value-at-Risk (VaR) constraint, which can bind occasionally. As default risk rises, the constraint may bind, generating a fall in demand for sovereign bonds that can be accompanied by a rise in the risk premium if other agents are more risk averse. In turn, the rise in risk premium leads to a feedback effect through debt accumulation dynamics and the probability of government default.

Keywords: Banking; Asset pricing; Sovereign default; Fiscal limits (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jinteco.2020.103298

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