Macroeconomic volatility, debt dynamics, and sovereign interest rate spreads
While the relationship between volatility and risk is central to much of the financial literature it has not been incorporated systematically into assessment of sovereign debt sustainability. This paper attempts to fill this gap by studying how the probability distribution of sovereign debt to GDP ratios depends on the stochastic properties of underlying variables such as the real interest rate, the real growth rate, and the primary budget deficit. Due to the highly non-linear relationship between these variables and the debt ratios, Monte-Carlo simulations have to be used to estimate the probability distribution at different horizons. Using the right-hand tail of the distribution as a measure of the risk, we are able to show how the volatility of the underlying variables as well as potential interactions between them influences country risk. Using estimates of volatility parameters of a sample of developed and emerging markets, we construct risk measures for each of them. We hypothesize that this risk measure should be positively correlated with the spread of sovereign bonds of the countries. Preliminary econometric tests suggest that this is indeed the case. Thus, while conventional analyses of the determinants of sovereign spreads have not focused on volatility dynamics, financial markets seem to have incorporated it in sovereign bond pricing.
|Date of creation:||14 May 2004|
|Date of revision:|
|Contact details of provider:|| Postal: P.O. Box 36, 1211 Geneva 21|
Phone: ++41 22 731 17 30
Fax: ++41 22 738 43 06
Web page: http://www.graduateinstitute.ch/economics
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Michael Gavin & Roberto Perotti, 1997. "Fiscal Policy in Latin America," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 11-72 National Bureau of Economic Research, Inc.
- Ahmed, S. & Rogers, J.H., 1993.
"Government Budget Deficits and Trade Deficits: Are Present Value Constraints Satisfied in Long-Term Data?,"
5-93-6, Pennsylvania State - Department of Economics.
- Ahmed, Shaghil & Rogers, John H., 1995. "Government budget deficits and trade deficits Are present value constraints satisfied in long-term data?," Journal of Monetary Economics, Elsevier, vol. 36(2), pages 351-374, November.
- Shaghil Ahmed & John H. Rogers, 1995. "Government budget deficits and trade deficits: are present value constraints satisfied in long-term data?," International Finance Discussion Papers 494, Board of Governors of the Federal Reserve System (U.S.).
- Reinhart, Carmen, 2004.
"Debt intolerance: Executive summary,"
13398, University Library of Munich, Germany.
- Hakkio, Craig S & Rush, Mark, 1991. "Is the Budget Deficit "Too Large?"," Economic Inquiry, Western Economic Association International, vol. 29(3), pages 429-45, July.
- Luis CatÃ£o & Sandeep Kapur, 2004. "Missing Link; Volatility and the Debt Intolerance Paradox," IMF Working Papers 04/51, International Monetary Fund.
- Marcel Peter, 2002. "Estimating Default Probabilities of Emerging Market Sovereigns: A New Look at a Not-So-New Literature," IHEID Working Papers 06-2002, Economics Section, The Graduate Institute of International Studies.
- Wilcox, David W, 1989.
"The Sustainability of Government Deficits: Implications of the Present-Value Borrowing Constraint,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 21(3), pages 291-306, August.
- David W. Wilcox, 1987. "The substainability of government deficits: implications of the present- value borrowing constraint," Working Paper Series / Economic Activity Section 77, Board of Governors of the Federal Reserve System (U.S.).
- James D. Hamilton & Marjorie A. Flavin, 1985.
"On the Limitations of Government Borrowing: A Framework for Empirical Testing,"
NBER Working Papers
1632, National Bureau of Economic Research, Inc.
- Hamilton, James D & Flavin, Marjorie A, 1986. "On the Limitations of Government Borrowing: A Framework for EmpiricalTesting," American Economic Review, American Economic Association, vol. 76(4), pages 808-19, September.
- Barry Eichengreen & Ashoka Mody, 2000. "What Explains Changing Spreads on Emerging Market Debt?," NBER Chapters, in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 107-134 National Bureau of Economic Research, Inc.
- Kremers, Jeroen J. M., 1989. "U.S. Federal indebtedness and the conduct of fiscal policy," Journal of Monetary Economics, Elsevier, vol. 23(2), pages 219-238, March.
- Uctum, Merih & Wickens, Michael, 2000.
" Debt and Deficit Ceilings, and Sustainability of Fiscal Policies: An Intertemporal Analysis,"
Oxford Bulletin of Economics and Statistics,
Department of Economics, University of Oxford, vol. 62(2), pages 197-222, May.
- Uctum, Merih & Wickens, Michael R., 1997. "Debt and Deficit Ceilings, and Sustainability of Fiscal Policies: An Intertemporal Analysis," CEPR Discussion Papers 1612, C.E.P.R. Discussion Papers.
- Merih Uctum & Michael Wickens, 1996. "Debt and deficit ceilings, and sustainability of fiscal policies: an intertemporal analysis," Research Paper 9615, Federal Reserve Bank of New York.
- Hong G. Min, 1998. "Determinants of emerging market bond spread : do economic fundamentals matter?," Policy Research Working Paper Series 1899, The World Bank.
- Trehan, Bharat & Walsh, Carl E, 1991.
"Testing Intertemporal Budget Constraints: Theory and Applications to U.S. Federal Budget and Current Account Deficits,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 23(2), pages 206-23, May.
- Bharat Trehan & Carl E. Walsh, 1988. "Testing intertemporal budget constraints: theory and applications to U. S. federal budget and current account deficits," Working Papers in Applied Economic Theory 88-03, Federal Reserve Bank of San Francisco.
- Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
- Gianluigi Ferrucci, 2003. "Empirical determinants of emerging market economies' sovereign bond spreads," Bank of England working papers 205, Bank of England.
- Theodore M. Barnhill & George Kopits, 2003. "Assessing Fiscal Sustainability Under Uncertainity," IMF Working Papers 03/79, International Monetary Fund.
- Beck, Roland, 2001. "Do country fundamentals explain emerging market bond spreads?," CFS Working Paper Series 2001/02, Center for Financial Studies (CFS).
- Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
- Giovanni Dell'Ariccia & Jeronimo Zettelmeyer & Isabel Schnabel, 2002. "Moral Hazard and International Crisis Lending; A Test," IMF Working Papers 02/181, International Monetary Fund.
- Bartolini, Leonardo & Cottarelli, Carlo, 1994. "Government Ponzi games and the sustainability of public deficits under uncertainty," Ricerche Economiche, Elsevier, vol. 48(1), pages 1-22, March.
- Enrica Detragiache & Antonio Spilimbergo, 2001. "Crises and Liquidity; Evidence and Interpretation," IMF Working Papers 01/2, International Monetary Fund.
- Márcio Gomes Pinto Garcia & Roberto Rigobon, 2004.
"A Risk Management Approach to Emerging Market’s Sovereign Debt Sustainability with an Application to Brazilian Data,"
Textos para discussão
484, Department of Economics PUC-Rio (Brazil).
- Marcio Garcia & Roberto Rigobon, 2004. "A Risk Management Approach to Emerging Market's Sovereign Debt Sustainability with an Application to Brazilian Data," NBER Working Papers 10336, National Bureau of Economic Research, Inc.
- Morris Goldstein, 2003. "Debt Sustainability, Brazil, and the IMF," Working Paper Series WP03-1, Peterson Institute for International Economics.
When requesting a correction, please mention this item's handle: RePEc:gii:giihei:heiwp03-2004. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Rahul Mehrotra)
If references are entirely missing, you can add them using this form.