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News, sovereign debt maturity, and default risk

Maximiliano Dvorkin (), Juan Sanchez, Horacio Sapriza and Emircan Yurdagul ()

No 2018-33, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Leading into a debt crisis, interest rate spreads on sovereign debt rise before the economy experiences a decline in productivity, suggesting that news may play an important role in these episodes. The empirical evidence also shows that a news shock has a significantly larger contemporaneous impact on sovereign credit spreads than a comparable shock to labor productivity. We develop a quantitative model of news and sovereign debt default with endogenous maturity choice that generates impulse responses very similar to the empirical estimates. The model allows us to interpret the empirical evidence and to identify key parameters. We find that, first, the increase in sovereign yield spreads around a debt crisis episode is due mostly to the lower expected productivity following a bad news shock, and not to the borrowing choices of the government. Second, a shorter debt maturity increases the chance that bad news shocks trigger a debt crisis. Third, an increase in the precision of news allows the government to improve its debt maturity management, especially during periods of high financial stress, and thus face lower spreads and default risk while holding the amount of debt constant.

Keywords: Crises; News; Default; Spreads; Maturity; Country Risk; Sovereign Debt (search for similar items in EconPapers)
JEL-codes: F34 F41 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-fmk and nep-opm
Date: 2018-10-31, Revised 2018-11-20
Note: Title of previous version: News, Country Risk, and Sovereign Default
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DOI: doi.org/10.20955/wp.2018.033

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