Fiscal Discoveries and Sudden Decouplings
Luis Catão (),
Ana Fostel and
Romain Ranciere ()
No 9368, CEPR Discussion Papers from C.E.P.R. Discussion Papers
The recent Eurozone debt crisis has witnessed sharp decouplings in cross-country bond yields without commensurate shifts in relative fundamentals. We rationalize this phenomenon in a model wherein countries with different fundamentals are on different equilibrium paths all along, but which become discernable only during bad times. Key ingredients are cross-country differences in the volatility and persistence of fiscal revenue shocks combined with asymmetric information on country-specific fiscal shocks. Differences in the cyclicality of fiscal revenues affect the option value of borrowing and resulting default risk; unobservability of fiscal shocks makes bond pricing responsive to market actions. When tax revenues are hit by common positive shocks, no country increases net debt and interest spreads stay put. When a common negative revenue shock hits and is persistent, low volatility countries adjust spending while others resort to borrowing. This difference signals a relative deterioration of fiscal outlooks, interest spreads jump and decoupling takes place.
Keywords: Default; Eurozone Debt Crisis; Fiscal Gaps; Information Asymmetry; Perfect Bayesian Equilibrium; Pesistence; Sovereign Debt; Volatility (search for similar items in EconPapers)
JEL-codes: E62 F34 G15 H3 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-eec, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations Track citations by RSS feed
Downloads: (external link)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at email@example.com
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:9368
Ordering information: This working paper can be ordered from
http://www.cepr.org/ ... ers/dp.php?dpno=9368
Access Statistics for this paper
More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ..
Series data maintained by (). This e-mail address is bad, please contact .