Sovereign risk dynamics in the EU: The time varying relevance of fiscal and external (im)balances*

Antonio Afonso, José Alves and Sofia Monteiro

Journal of International Financial Markets, Institutions and Money, 2024, vol. 94, issue C

Abstract: Acknowledging the potential detrimental impact that twin-deficits can have on sovereign risk, this study uses a two-step approach to assess the impact of fiscal and external sustainability on sovereign risk dynamics for a panel of 27 European economies from Q4 2001 to Q3 2022. We first estimate a country-specific time-varying measure of fiscal sustainability, based on the cointegration between government revenues and expenditures and external sustainability, derived from the cointegration of exports and imports. We then use these time-varying coefficients to assess their impact on sovereign risk, proxied by 10-year CDS and CDS spreads (against the US), employing a Weighted Least Squares (WLS) analysis. Notably, we show that an improvement of both fiscal and external sustainability lead to a reduction in sovereign risk. This phenomenon is particularly pronounced for countries experiencing an upward trajectory in public debt levels.

Keywords: Sovereign Risk; Fiscal Sustainability; External Sustainability; CDS; CDS spreads (search for similar items in EconPapers)
JEL-codes: C23 F45 G23 G32 H63 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Sovereign Risk Dynamics in the EU: The Time Varying Relevance of Fiscal and External (Im)balances (2024)
Working Paper: Sovereign risk dynamics in the EU: the time varying relevance of fiscal and external (im)balances (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:94:y:2024:i:c:s1042443124000921

DOI: 10.1016/j.intfin.2024.102026

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