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Legal Risk Premia During the Euro-Crisis: The Role of Credit and Redenomination Risk

Author

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  • Nordvig, Jens

    (Nomura Securities International, Inc.)

Abstract

Using several new datasets, I document the role of legal risk premia in bond yields during the Euro-crisis. I find evidence of a rising premium especially in late 2011 and mid-2012 on bonds with foreign governing law relative to those with local governing law (and otherwise similar characteristics). The results illustrate that legal risk premia spiked at the height of the crisis in the Eurozone, when investors were willing to pay a premium for the additional protection offered by foreign law bonds. I show that this governing law premium can be linked to both credit risk (expected haircuts) and redenomination risk (expected currency depreciation). This paper is the first to empirically link the governing law premium to redenomination risk. I find evidence that redenomination risk is an independent driving force of governing law spreads over and above credit risk, although it is analytically challenging to separate the two risk factors. My findings, while not conclusive, are consistent with the consensus in the literature on contract law, which argues that local law financial instruments should be more susceptible to redenomination in a scenario of a country exiting the Eurozone.

Suggested Citation

  • Nordvig, Jens, 2015. "Legal Risk Premia During the Euro-Crisis: The Role of Credit and Redenomination Risk," Discussion Papers on Economics 10/2015, University of Southern Denmark, Department of Economics.
  • Handle: RePEc:hhs:sdueko:2015_010
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    References listed on IDEAS

    as
    1. Barry Eichengreen & Ashoka Mody, 2004. "Do Collective Action Clauses Raise Borrowing Costs?," Economic Journal, Royal Economic Society, vol. 114(495), pages 247-264, April.
    2. Patrick Bolton & Olivier Jeanne, 2007. "Structuring and Restructuring Sovereign Debt: The Role of a Bankruptcy Regime," Journal of Political Economy, University of Chicago Press, vol. 115(6), pages 901-924, December.
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    Cited by:

    1. Jelic, Ranko & Zeng, Yiming & Karouzakis, Nikolaos, 2023. "Foreign-law premium for European high-yield corporate bonds," Finance Research Letters, Elsevier, vol. 52(C).
    2. Chamon, Marcos & Schumacher, Julian & Trebesch, Christoph, 2018. "Foreign-Law Bonds: Can They Reduce Sovereign Borrowing Costs?," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, vol. 114, pages 164-179.

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    More about this item

    Keywords

    General financial markets; International finance; Foreign exchange; Contract law; Financial econometrics; Financial crisis;
    All these keywords.

    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • F30 - International Economics - - International Finance - - - General
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G01 - Financial Economics - - General - - - Financial Crises
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • K20 - Law and Economics - - Regulation and Business Law - - - General

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