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Mispricing of Risk in Sovereign Bond Markets with Asymmetric Information

Author

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  • Mihm Benedikt

    (Otto-von-Guericke University Magdeburg, Universitätspl. 2, Magdeburg, Germany)

Abstract

The likelihood that a government will repay its sovereign debt depends both on the amount of debt it issues and on the government’s future ability to repay. Whilst the former is publicly observable, the government may have more information about the latter than investors. This paper shows that this asymmetric information problem impairs the market’s ability to differentiate economies according to their fiscal sustainability, and can lead to a disconnect between bond prices and default risk. The model can help rationalise the behaviour of Eurozone bond prices prior to the recent European sovereign debt crisis.

Suggested Citation

  • Mihm Benedikt, 2016. "Mispricing of Risk in Sovereign Bond Markets with Asymmetric Information," German Economic Review, De Gruyter, vol. 17(4), pages 491-511, December.
    • Handle: RePEc:bpj:germec:v:17:y:2016:i:4:p:491-511
    DOI: 10.1111/geer.12068
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    Cited by:

    1. Joo, Hyungseok & Lee, Yoon-Jin & Yoon, Young-Ro, 2023. "Effects of information quality on signaling through sovereign debt issuance," Journal of Economic Behavior & Organization, Elsevier, vol. 207(C), pages 279-304.

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