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Rating agencies, self-fulfilling prophecy and multiple equilibria? An empirical model of the European sovereign debt crisis 2009-2011

Manfred Gärtner () and Björn Griesbach

No 1215, Economics Working Paper Series from University of St. Gallen, School of Economics and Political Science

Abstract: We explore whether experiences during Europe's sovereign debt crisis support the notion that governments faced scenarios of self-fulfilling prophecy and multiple equilibria. To this end, we provide estimates of the effect of interest rates and other macroeconomic variables on sovereign debt ratings, and estimates of how ratings bear on interest rates. We detect a nonlinear effect of ratings on interest rates which is strong enough to generate multiple equilibria. The good equilibrium is stable, ratings are excellent and interest rates are low. A second unstable equilibrium marks a threshold beyond which the country falls into an insolvency trap from which it may only escape by exogenous intervention. Coefficient estimates suggest that countries should stay well within the A section of the rating scale in order to remain reasonably safe from being driven into eventual default.

Keywords: Eurozone; crisis; sovereign debt; credit spreads; bond yields; rating agencies; multiple equilibria; self-fulfilling prophecy (search for similar items in EconPapers)
JEL-codes: F3 G24 H6 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2012-06
New Economics Papers: this item is included in nep-eec
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http://ux-tauri.unisg.ch/RePEc/usg/econwp/EWP-1215.pdf (application/pdf)

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Journal Article: Rating Agencies, Self-Fulfilling Prophecy and Multiple Equilibria? An Empirical Model of the European Sovereign Debt Crisis 2009-2011 (2017) Downloads
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