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Demand for sovereign bonds in the periphery: a regimeswitching approach

Victor Echevarria-Icaza ()
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Victor Echevarria-Icaza: Universidad Complutense de Madrid Departamento de Fundamentos del Análisis Económico II (Economía Cuantitativa)

No 16-02, Working Papers from Asociación Española de Economía y Finanzas Internacionales

Abstract: The rise in sovereign bond holdings in stress countries could deepen a recession by allocating resources away from the private sector. Our paper investigates whether the demand function for sovereign bonds changed in the crisis period and the causes of such a change. We show that it did, and that bond holdings rose more than they would have in normal times given a set of fundamentals. However, we find this happened only for a short span of time, and similar behavior by OFIs suggests that the 0 risk weight on sovereign bond holdings was not the cause. Instead, sovereign stress is the likely driver: policies aimed at lowering the sovereign-bank nexus should target sovereign stress. Acknowledgements: The author is grateful to Simón Sosvilla for his comments and support. The author also thanks Christian Castro for his suggestions to an earlier draft.

Date: 2016-02
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