Secondary markets in turbulent times: distortions, disruptions and bailouts

Fernando Broner, Aitor Erce, Alberto Martin and Jaume Ventura
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Jaume Ventura: CREI and Universitat Pompeu Fabra

No 260, 2013 Meeting Papers from Society for Economic Dynamics

Abstract: Countries in the Euro periphery have gone from zero sovereign spreads and healthy economic growth in 2006 to sovereign debt problems and deep recessions by 2010. This has been accompanied by a transfer of sovereign debts from foreigners to domestic residents and a shift in domestic portfolios from credit to firms and consumers to credit to the public sector. In this paper, we propose a growth model with sovereign debts in the presence of secondary markets that accounts for these observations. The model displays self-fulfilling rollover crises: if foreigners start worrying about default they sell sovereign debts to domestic residents; this crowds out investment and lowers growth; this reduces the cost of default and increases its probability, validating foreigners' fears. The maturity structure of sovereign debts is irrelevant, as secondary markets allow the reallocation of both maturing and non-maturing debts. In other words, secondary markets make long-term debts effectively short-term with regards to the existence of rollover crises.

Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed013:260

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