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Regime-switches in the Rollover of Sovereign Risk

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  • Elton Beqiraj
  • Valeria Patella
  • Massimiliano Tancioni

Abstract

This paper presents a unified analysis of the run-up of sovereign and credit risk in an environment where latent factors, along with fundamentals, feed financial crises. A Markov-switching VAR in four variables (debt, GDP, sovereign and corporate spreads) is estimated on Italian 1990-2018 data. The model displays both stochastic and systematic switches in the determination of spreads, and historically identifies: i ) a high sovereign stress state of high and volatile spreads, which lines up mostly with crisis times; ii ) a high credit stress state of tight connections between spreads, prevailing on the pre-euro and global crisis periods. We find that high spreads in high stress states are mainly explained by latent factors, orthogonal to fundamentals and possibly linked to agents' expectations. In normal times, instead, fiscal shocks are expansionary and trigger drops in spreads.

Suggested Citation

  • Elton Beqiraj & Valeria Patella & Massimiliano Tancioni, 2019. "Regime-switches in the Rollover of Sovereign Risk," Working Papers in Public Economics 191, University of Rome La Sapienza, Department of Economics and Law.
    • Handle: RePEc:sap:wpaper:wp191
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    More about this item

    Keywords

    Fundamentals; Latent factors; Sovereign spreads; Credit spreads; Financial crisis;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • G01 - Financial Economics - - General - - - Financial Crises
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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