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Rechts- und Staatswissenschaftliche Fakultät - Jahrgang 2014


Titel Sovereign borrowing and sovereign default
Autor Ronald I. U. Rühmkorf
Publikationsform Dissertation
Abstract In the course of the global financial crisis, countries that did not experience a sovereign debt crisis for several decades suddenly faced increasing sovereign default risk spreads as investors started to doubt the sustainability of fiscal positions. Several European countries struggled to avoid a government default and Greece defaulted in 2012. The three chapters of this thesis analyze several important questions related to sovereign borrowing and sovereign default risk that have received much attention in the wake of the European sovereign debt crisis.
Chapter 1 investigates whether the co-movement of the fiscal balance and the current account depends on the indebtedness of the government. The first part of the analysis presents the estimation of a dynamic panel threshold model for 15 European countries to quantify the influence of the level of government debt on the relationship between the fiscal balance and the current account. Below the estimated threshold of 72 percent government debt-to-GDP a significant, positive relationship between the fiscal balance and the current account is found. In contrast, above the threshold the partial correlation is insignificant with a point estimate around zero. The second part of the analysis provides a structural explanation for the empirical evidence based on a small open economy model allowing for the possibility of sovereign default. High government debt-to-GDP ratios raise non-linear sovereign default risk premia due to the increasing probability of government default and lead to a higher uncertainty about future taxes. Therefore, private saving increases while fiscal deficits are expanding, leading to a less pronounced current account deficit. In line with the empirical evidence, the model-based correlation of the fiscal balance and the current account declines by 0.15 when moving from a low government debt regime to a high government debt regime.
Chapter 2 relates to the European sovereign debt crisis during which the International Monetary Fund (IMF) together with the European Stability Mechanism (ESM) and its predecessors provided financial assistance to countries facing financial distress. The chapter investigates within a quantitative model of sovereign default how the provision of financial assistance by a supranational agency like the IMF affects the debt level and the probability of a government default. The analysis shows that for given government debt levels the provision of financial assistance helps to reduce the number of defaults that are either due to runs by private investors or due to bad fundamentals. In equilibrium, the smaller default probability translates into lower sovereign risk spreads for given debt levels. The resulting lower borrowing costs, however, induce the government to accumulate higher levels of debt and thus increase default incentives. Simulations reveal that overall the availability of financial assistance reduces the number of defaults that occur due to self-fulfilling runs by private investors. However, at the same time it raises average debt levels strongly and causes an overall increase of the probability of default.
Chapter 3 studies how the option to devalue the currency to reduce the debt burden affects the average debt level and the default incentives of the government. While some governments borrow from foreign investors in foreign currency, many governments borrow from foreign investors primarily in domestic currency. Borrowing in domestic currency provides the government with the option to partially default on its debt by devaluing its currency. The option to devalue gives the government a higher degree of flexibility and might reduce the frequency of outright defaults. In contrast, pegging the exchange rate to a foreign currency deprives the government of the option to devalue its currency to reduce the real debt burden and might therefore increase the default probability. For the analysis a quantitative model of sovereign default and devaluation is considered. Simulations show that average debt is higher when the government cannot devalue. The elimination of devaluation risk leads to lower sovereign spreads at low government debt levels. Lower sovereign spreads induce the government to accumulate larger amounts of debt. The probability of a sovereign default and the average spread increase. This is due to both higher average debt levels and a lower flexibility when facing sovereign debt crisis as the option to devalue to lower the value of the debt burden is not existent anymore.
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© Universitäts- und Landesbibliothek Bonn | Veröffentlicht: 23.01.2014