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Rating agencies, self-fulfilling prophecy and multiple equilibria? An empirical model of the European sovereign debt crisis 2009-2011

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  • Gärtner, Manfred

    ()

  • Griesbach, Björn

    ()

Abstract

We explore whether experiences during Europe's sovereign debt crisis support the notion that governments faced scenarios of self-fulfilling prophecy and multiple equilibria. To this end, we provide estimates of the effect of interest rates and other macroeconomic variables on sovereign debt ratings, and estimates of how ratings bear on interest rates. We detect a nonlinear effect of ratings on interest rates which is strong enough to generate multiple equilibria. The good equilibrium is stable, ratings are excellent and interest rates are low. A second unstable equilibrium marks a threshold beyond which the country falls into an insolvency trap from which it may only escape by exogenous intervention. Coefficient estimates suggest that countries should stay well within the A section of the rating scale in order to remain reasonably safe from being driven into eventual default.

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File URL: http://www1.vwa.unisg.ch/RePEc/usg/econwp/EWP-1215.pdf
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Bibliographic Info

Paper provided by University of St. Gallen, School of Economics and Political Science in its series Economics Working Paper Series with number 1215.

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Length: 35 pages
Date of creation: Jun 2012
Date of revision:
Handle: RePEc:usg:econwp:2012:15

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Keywords: Eurozone; crisis; sovereign debt; credit spreads; bond yields; rating agencies; multiple equilibria; self-fulfilling prophecy;

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  1. Rabah Arezki & Bertrand Candelon & Amadou Sy, 2011. "Sovereign Rating News and Financial Markets Spillovers: Evidence from the European Debt Crisis," CESifo Working Paper Series 3411, CESifo Group Munich.
  2. Alesina, Alberto F & Prati, Alessandro & Tabellini, Guido, 1989. "Public Confidence and Debt Management: A Model and a Case Study of Italy," CEPR Discussion Papers 351, C.E.P.R. Discussion Papers.
  3. Mark A. Carlson & Galina B. Hale, 2005. "Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Role-over," Cowles Foundation Discussion Papers 1506, Cowles Foundation for Research in Economics, Yale University.
  4. Schuknecht, Ludger & von Hagen, Jürgen & Wolswijk, Guido, 2009. "Government Bond Risk Premiums in the EU revisited: The Impact of the Financial Crisis," CEPR Discussion Papers 7499, C.E.P.R. Discussion Papers.
  5. Manfred Gärtner & Björn Griesbach & Florian Jung, 2011. "PIGS or Lambs? The European Sovereign Debt Crisis and the Role of Rating Agencies," International Advances in Economic Research, Springer, vol. 17(3), pages 288-299, August.
  6. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  7. António Afonso & Pedro Gomes & Philipp Rother, 2007. "What “hides” behind sovereign debt ratings?," Working Paper Series 711, European Central Bank.
  8. International Monetary Fund, 2012. "Are Rating Agencies Powerful? An Investigation into the Impact and Accuracy of Sovereign Ratings," IMF Working Papers 12/23, International Monetary Fund.
  9. Cole, Harold L. & Kehoe, Timothy J., 1996. "A self-fulfilling model of Mexico's 1994-1995 debt crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 309-330, November.
  10. Ernan Haruvy & Yaron Lahav & Charles N. Noussair, 2007. "Traders' Expectations in Asset Markets: Experimental Evidence," American Economic Review, American Economic Association, vol. 97(5), pages 1901-1920, December.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Ideen und Interessen
    by Tobias Straumann in Never mind the markets on 2012-07-31 04:00:32
  2. La rolo de la taksagentejoj en la e?rokrizo
    by Ri?o in Riŝo's blog on 2012-07-31 04:16:59
  3. Lese-Tipps: spannende Hintergründe zur Finanzkrise
    by Steffen Greschner in x Politics on 2012-07-31 17:42:18

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