Bounding the productivity default shock: Evidence from the The European Sovereign Debt Crisis

Jorge Alonso-Ortiz (), Esteban Colla-De-Robertis and Jose-Maria Da-Rocha
Authors registered in the RePEc Author Service: Jose Maria Da Rocha

MPRA Paper from University Library of Munich, Germany

Abstract: Interest rate spreads on sovereign debt were negatively correlated with the evolution of stock prices during The European Sovereign Debt Crisis. In particular, for a sample of 9 european countries there was a year (between 2009 and 2012) in which the correlation between stock prices and spreads was almost -1. We use this fact to estimate the upper bound of productivity default shocks using a continuous time structural model of default. At every instant the government maximizes expected tax revenues, where the only source of uncertainty is TFP, which follows a regime switching brownian motion. By estimating TFP regimes, to match interest rate spreads on sovereign debt and stock prices, we compute the ratio of the productivity if there was a default relative to the no default benchmark. This is a measure on how much productivity could countries loose at default. We found a robust negative relation between the costs of default and the probability of default. That is, financial markets incorporate into prices the risk of default immediately.

Keywords: Default; Sovereign Debt; Financial Markets; Productivity (search for similar items in EconPapers)
JEL-codes: E30 E44 G15 (search for similar items in EconPapers)
Date: 2014-04-01
New Economics Papers: this item is included in nep-eec, nep-eff and nep-mac
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https://mpra.ub.uni-muenchen.de/67019/8/MPRA_paper_67019.pdf revised version (application/pdf)

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