Moral Hazard and Bail-Out in Fiscal Federations: Evidence for the German Länder
AbstractWe identify investor moral hazard in the German fiscal federation. Our identification strategy is based on a variable, which was used by the German Federal Constitutional Court as an indicator to determine eligibility of two German states (Länder) to a bail-out, the interest payments-to-revenue ratio. While risk premia measured in the German sub-national bond market react significantly to the relative debt level of a state (Land), we also find that a larger interest payments-to-revenue ratio counter-intuitively lowers risk premia significantly. Furthermore, with increasing values the risk premia decrease more strongly. This is evidence of investor moral hazard, because a larger indicator value increases the likelihood of receiving a bail-out payment. Our findings are robust to a variety of sample changes. In addition, we provide a case study of the recent Federal Constitutional Court ruling on the Land Berlin, which had filed for additional federal funds. The negative response of the court did not lead to a change in financial markets' bail-out expectations. In sum, our results indicate significant investor moral hazard in the sub-national German bond market. Copyright 2008 The Authors. Journal compilation 2008 Blackwell Publishing Ltd.
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Volume (Year): 61 (2008)
Issue (Month): 3 (08)
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- Heppke-Falk, Kirsten H. & Wolff, Guntram B., 2007. "Moral hazard and bail-out in fiscal federations: evidence for the German Länder," Discussion Paper Series 1: Economic Studies 2007,07, Deutsche Bundesbank, Research Centre.
- F34 - International Economics - - International Finance - - - International Lending and Debt Problems
- H6 - Public Economics - - National Budget, Deficit, and Debt
- H7 - Public Economics - - State and Local Government; Intergovernmental Relations
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
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