We identify investor moral hazard in the German fiscal federation. Our identification strategy is based on a variable, which was used by the German Federal Constitutional Court as an indicator to determine eligibility of two German states (Länder) to a bail-out, the interest payments-to-revenue ratio. While risk premia measured in the German sub-national bond market react significantly to the relative debt level of a state (Land), we also find that a larger interest payments-to-revenue ratio counter-intuitively lowers risk premia significantly. Furthermore, with increasing values the risk premia decrease more strongly. This is evidence of investor moral hazard, because a larger indicator value increases the likelihood of receiving a bail-out payment. Quantitatively, the effects are, however, quite small. Our findings are robust to a variety of sample changes. In addition, we provide a case study of the recent Federal Constitutional Court ruling on the Land Berlin, which had filed for additional federal funds. The negative response of the court did not lead to a change in financial markets? bail-out expectations. In sum, our results indicate significant investor moral hazard in the sub-national German bond market. --
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Find related papers by JEL classification: F34 - International Economics - - International Finance - - - International Lending and Debt Problems H6 - Public Economics - - National Budget, Deficit, and Debt H7 - Public Economics - - State and Local Government; Intergovernmental Relations G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies G15 - Financial Economics - - General Financial Markets - - - International Financial Markets E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
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Grossman, S.J. & Miller, M.H., 1988.
"Liquidity And Market Structure,"
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88, Princeton, Department of Economics - Financial Research Center.
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