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Dynamic Panics: Theory and Application to the Eurozone

Zachary Stangebye ()

MPRA Paper from University Library of Munich, Germany

Abstract: It is shown in a standard quantitative model of sovereign debt and default that sentiment shocks can alter the distribution of fundamental defaults. The channel through which this occurs is a new type of dynamic lender coordination problem in sovereign debt markets that I call a dynamic panic. During a dynamic panic of this kind, expectations of future negative investor sentiments dilute the price of long-term debt; the sovereign's optimal response to such a panic can be to borrow aggressively, which justifies investors' fears of dilution. Such panics generate naturally many of the unique features the recent Eurozone crisis, and so I explore policy implications in this environment. I find that rate ceilings are an ineffective policy tool but that liquidity provision, appropriately implemented, can eliminate such panics.

Keywords: Sovereign Debt Crises; Confidence-Driven Crises; Long-Term Debt (search for similar items in EconPapers)
JEL-codes: E44 F34 G01 H63 (search for similar items in EconPapers)
Date: 2015-04-14
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
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