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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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References

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  1. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 91-116, January.
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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 taksad-agentejoj en la eÅ­rokrizo
    by Riŝo in Riŝo's blog on 2012-08-01 07:25:47
  3. Lese-Tipps: spannende Hintergründe zur Finanzkrise
    by Steffen Greschner in x Politics on 2012-07-31 17:42:18
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Cited by:
  1. Finn Marten Körner & Hans-Michael Trautwein, 2013. "Sovereign Credit Ratings and the Transnationalization of Finance - Evidence from a Gravity Model of Portfolio Investment," ZenTra Working Papers in Transnational Studies 20 / 2013, ZenTra - Center for Transnational Studies, revised Feb 2014.
  2. Gärtner, Manfred & Griesbach, Björn & Mennillo, Giulia, 2013. "The near-death experience of the Celtic Tiger: a model-driven narrative from the European sovereign debt crisis," Economics Working Paper Series 1321, University of St. Gallen, School of Economics and Political Science.
  3. Mevlud Islami & Paul Welfens, 2013. "Financial market integration, stock markets and exchange rate dynamics in Eastern Europe," International Economics and Economic Policy, Springer, vol. 10(1), pages 47-79, March.

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