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Structured Eurobonds

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  • Christian Bauer
  • Bernhard Herz
  • Alexandra Hild

Abstract

This paper develops a market-based approach to implement so called Eurobonds, i.e. common sovereign debt securities of European Monetary Union (EMU) countries. By applying an asset-backed security (ABS) approach positive implications of a common bond can be achieved and negative incentives (e.g. moral hazard) can be prevented. Within an ABS structure a special purpose vehicle (SPV) buys a portfolio of EMU countries debt instruments (pooling) and then issues a set of subordinated Eurobonds with varying risk and rating (tranching). By pooling and tranching the default risk is concentrated in one part of the capital structure, resulting in a large share of less risky securities and overall risk premia reduction. A fraction of the cash flows from the SPV to the countries is diverted to a trust fund, which covers the first losses in case of a country default. By contrast to propositions on Eurobonds made so far, our proposal has one major advantage: All EMU countries can benefit from participating in the ABS-structure. These benefits are driven by the following reasons: Firstly, we only introduce partial liability (10 % of initial notional) instead of joint liability in order to limit moral hazard. Secondly, interest gains are distributed among all participating and not defaulting countries. Our simulation study shows that on average all EMU member states - both high rated and low rated countries - gain by taking part in a Eurobond ABS due to the implied diversification and tranching effects. Average savings range between 8 % and 33 % of the total credit amount. Nonetheless, in the worst case scenario, there is a probability of a disprofit ranging between 5.5 % and 0 %. In our simulation Germany and Greece represent the two opposite ends of the range and therefore serve as example in the discussion.

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File URL: http://www.uni-trier.de/fileadmin/fb4/prof/VWL/EWF/Research_Papers/2011-09.pdf
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Bibliographic Info

Paper provided by University of Trier, Department of Economics in its series Research Papers in Economics with number 2011-09.

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Length: 42 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:trr:wpaper:201109

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Related research

Keywords: Eurobonds; EMU; asset-backed securities (ABS); financial instruments; indebtedness;

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References

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  1. Federico Sturzenegger & Jeromin Zettelmeyer, 2007. "Debt Defaults and Lessons from a Decade of Crises," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262195534, December.
  2. Sergio Mayordomo & Juan Ignacio Peña & Eduardo S. Schwartz, 2009. "Towards a Common European Monetary Union Risk Free Rate," NBER Working Papers 15353, National Bureau of Economic Research, Inc.
  3. Reinhart, Carmen & Kaminsky, Graciela & Vegh, Carlos, 2003. "The unholy trinity of financial contagion," MPRA Paper 13878, University Library of Munich, Germany.
  4. Nicholas Economides & Roy C. Smith, 2011. "Trichet Bonds to Resolve the European Sovereign Debt Problem," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 11-05, New York University, Leonard N. Stern School of Business, Department of Economics.
  5. Bauer, Christian & Herz, Bernhard & Hoops, Stefan, 2008. "A Cheap Lunch for Emerging Markets: Removing International Financial Market Imperfections with Modern Financial Instruments," World Development, Elsevier, Elsevier, vol. 36(9), pages 1514-1530, September.
  6. Van Rijckeghem, Caroline & Weder, Beatrice, 2001. "Sources of contagion: is it finance or trade?," Journal of International Economics, Elsevier, Elsevier, vol. 54(2), pages 293-308, August.
  7. Ingo Fender & Janet Mitchell, 2005. "Structured finance: complexity, risk and the use of ratings," BIS Quarterly Review, Bank for International Settlements, June.
  8. Paulo Horta & Carlos Mendes & Isabel Vieira, 2008. "Contagion effects of the US Subprime Crisis on Developed Countries," CEFAGE-UE Working Papers 2008_08, University of Evora, CEFAGE-UE (Portugal).
  9. Eichengreen, Barry & Rose, Andrew & Wyplosz, Charles, 1996. " Contagious Currency Crises: First Tests," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 98(4), pages 463-84, December.
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