Sub-National Credit Risk and Sovereign Bailouts: Who Pays the Premium?

January 30, 2014

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Eva Jenkner, and Zhongjin Lu. Sub-National Credit Risk and Sovereign Bailouts: Who Pays the Premium?, (USA: International Monetary Fund, 2014) accessed December 26, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Studies have shown that markets may underprice sub-national governments’ risk on the implicit assumption that these entities would be bailed out by their central government in case of financial difficulties. However, the question of whether sovereigns pay a premium on their own borrowing as a result of (implicitly or explicitly) guaranteeing sub-entities’ debt has been explored only little. We use an event study approach with separate equations for two levels of government to test for a simultaneous increase in sovereign risk premia and decrease in sub-national risk premia—or a de facto transfer of risk from the latter to the former—on the day a sovereign bailout is announced. Using daily financial market data for Spain and its autonomous regions from January 2010 to June 2013, we find support for our risk transfer hypothesis. We estimate that the Spanish sovereign’s spread may have increased by around 70 basis points as a result of the central government’s support for fiscally distressed comunidades autónomas.

Subject: Bond yields, Credit, Credit default swap, Credit risk, Financial institutions, Financial regulation and supervision, Financial services, Market risk, Money, Yield curve

Keywords: Bailout, Bond yields, CDS instrument, CDS market, CDS spread, Central government, Credit, Credit default swap, Credit risk, Credit risk equation, Europe, Financial support, Fiscal policy, Interest rates, Market liquidity, Sovereign credit risk, Sovereign risk premium, Spain, Sub-national public finances, WP, Yield curve

Publication Details

Pages:

29
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/020
Stock No:

WPIEA2014020
ISBN:

9781484398876
ISSN:

1018-5941

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