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Sovereigns at risk: A dynamic model of sovereign debt and banking leverage

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  • Coimbra, Nuno

Abstract

This paper develops a dynamic model with heterogeneous investors and sovereign default to analyze the dynamic link between banking sector capitalization and sovereign bond yields. The banking sector is modelled as operating under a Value-at-Risk (VaR) constraint, which can bind occasionally. As default risk rises, the constraint may bind, generating a fall in demand for sovereign bonds that can be accompanied by a rise in the risk premium if other agents are more risk averse. In turn, the rise in risk premium leads to a feedback effect through debt accumulation dynamics and the probability of government default.

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  • Coimbra, Nuno, 2020. "Sovereigns at risk: A dynamic model of sovereign debt and banking leverage," Journal of International Economics, Elsevier, vol. 124(C).
    • Handle: RePEc:eee:inecon:v:124:y:2020:i:c:s0022199620300179
    DOI: 10.1016/j.jinteco.2020.103298
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    1. Hürtgen, Patrick, 2020. "Fiscal sustainability duringthe COVID-19 pandemic," Discussion Papers 35/2020, Deutsche Bundesbank.

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