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Sovereign Default Risk in the Euro-Periphery and the Euro-Candidate Countries

Hubert Gabrisch (), Lucjan Orlowski () and Toralf Pusch ()

No 2012002, Working Papers from Sacred Heart University, John F. Welch College of Business

Abstract: This study examines the key drivers of sovereign default risk in five euro area periphery countries and three euro-candidates that are currently pursuing independent monetary policies. We argue that the recent proliferation of sovereign risk premiums stems from both domestic and international sources. We focus on contagion effects of external financial crisis on sovereign risk premiums in these countries, arguing that the countries with weak fundamentals and fragile financial institutions are particularly vulnerable to such effects. The domestic fiscal vulnerabilities include: economic recession, less efficient government spending and a rising public debt. External ÔpushÕ factors entail increasing liquidity- and counter-party risks in international banking, as well as risk-hedging appetites of international investors embedded in local currency depreciation against the US Dollar. We develop a model capturing the internal and external determinants of sovereign risk premiums and test for the examined country groups. The results lead us to caution against premature fiscal consolidation in the aftermath of the global economic crisis, since such policy might actually worsen sovereign default risk. The model works well for the euro-periphery countries; it is less robust for the euro-candidates that upon a future euro adoption will have to pursue real economy growth oriented policies in order to mitigate a potential increase in sovereign default risk.

Keywords: Sovereign Default Risk; Euro area; Public Debt; Liquidity Risk; Counter-party Risk. (search for similar items in EconPapers)
JEL-codes: E43 E63 G12 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2012-08
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac and nep-opm
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