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Regime-switches in the Rollover of Sovereign Risk

Elton Beqiraj, Valeria Patella, Massimiliano Tancioni and Irene Maria Buso

No 191, Working Papers from University of Rome La Sapienza, Department of Public Economics

Abstract: This paper presents a unified analysis of the run-up of sovereign and credit risk in an environment where latent factors, along with fundamentals, feed financial crises. A Markov-switching VAR in four variables (debt, GDP, sovereign and corporate spreads) is estimated on Italian 1990-2018 data. The model displays both stochastic and systematic switches in the determination of spreads, and historically identifies: i) a high sovereign stress state of high and volatile spreads, which lines up mostly with crisis times; ii) a high credit stress state of tight connections between spreads, prevailing on the pre-euro and global crisis periods. We find that high spreads in high stress states are mainly explained by latent factors, orthogonal to fundamentals and possibly linked to agents' expectations. In normal times, instead, fiscal shocks are expansionary and trigger drops in spreads.

Keywords: Fundamentals; Latent factors; Sovereign spreads; Credit spreads; Financial crisis (search for similar items in EconPapers)
JEL-codes: E4 E6 G01 H63 (search for similar items in EconPapers)
Pages: 45
Date: 2019-11
New Economics Papers: this item is included in nep-eec, nep-mac and nep-ore
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