Advanced Search
MyIDEAS: Login to save this paper or follow this series

The European debt crisis: Defaults and market equilibrium

Contents:

Author Info

  • Marco Lagi
  • Yaneer Bar-Yam
Registered author(s):

    Abstract

    During the last two years, Europe has been facing a debt crisis, and Greece has been at its center. In response to the crisis, drastic actions have been taken, including the halving of Greek debt. Policy makers acted because interest rates for sovereign debt increased dramatically. High interest rates imply that default is likely due to economic conditions. High interest rates also increase the cost of borrowing and thus cause default to be likely. If there is a departure from equilibrium, increasing interest rates may contribute to---rather than be caused by---default risk. Here we build a quantitative equilibrium model of sovereign default risk that, for the first time, is able to determine if markets are consistently set by economic conditions. We show that over the period 2001-2012, the annually-averaged long-term interest rates of Greek debt are quantitatively related to the ratio of debt to GDP. The relationship shows that the market consistently expects default to occur if the Greek debt reaches twice the GDP. Our analysis does not preclude non-equilibrium increases in interest rates over shorter timeframes. We find evidence of such non-equilibrium fluctuations in a separate analysis. According to the equilibrium model, the date by which a half-default must occur is March 2013, almost one year after the actual debt write-down. Any acceleration of default by non-equilibrium fluctuations is significant for national and international interventions. The need for austerity or bailout costs would be reduced if market regulations were implemented to increase market stability to prevent short term interest rate increases. We similarly evaluate the timing of projected defaults without interventions for Portugal, Ireland, Spain and Italy to be March 2013, April 2014, May 2014, and July 2016, respectively. All defaults are mitigated by planned interventions.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://arxiv.org/pdf/1209.6369
    File Function: Latest version
    Download Restriction: no

    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1209.6369.

    as in new window
    Length:
    Date of creation: Sep 2012
    Date of revision:
    Handle: RePEc:arx:papers:1209.6369

    Contact details of provider:
    Web page: http://arxiv.org/

    Related research

    Keywords:

    This paper has been announced in the following NEP Reports:

    References

    No references listed on IDEAS
    You can help add them by filling out this form.

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:arx:papers:1209.6369. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.