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Time‐Varying Volatility, Default, And The Sovereign Risk Premium

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  • Hernán D. Seoane

Abstract

This article studies how volatility changes affect sovereign spreads in strategic default models. Volatility changes affect savings and sovereign spreads. However, the impact of volatility shocks is state dependent; when the economy has a low debt, an increase in volatility is prone to generate precautionary savings. Instead, with high debt, an increase in volatility is likely to induce an even further increase in debt and spreads, both in endowment and production economies. I document a positive correlation between sovereign spreads and aggregate income volatility for a set of European economies during the debt crisis, consistent with the model's implications.

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  • Hernán D. Seoane, 2019. "Time‐Varying Volatility, Default, And The Sovereign Risk Premium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 60(1), pages 283-301, February.
    • Handle: RePEc:wly:iecrev:v:60:y:2019:i:1:p:283-301
    DOI: 10.1111/iere.12353
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    Cited by:

    1. Johri, Alok & Khan, Shahed & Sosa-Padilla, César, 2022. "Interest rate uncertainty and sovereign default risk," Journal of International Economics, Elsevier, vol. 139(C).
    2. Pancrazi, Roberto & Seoane, Hernán D. & Vukotić, Marija, 2020. "Welfare gains of bailouts in a sovereign default model," Journal of Economic Dynamics and Control, Elsevier, vol. 113(C).
    3. de Ferra, Sergio & Mallucci, Enrico, 2022. "Sovereign risk matters: Endogenous default risk and the time-varying volatility of interest rate spreads," Journal of International Economics, Elsevier, vol. 134(C).

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