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Sub-National Credit Risk and Sovereign Bailouts: Who Pays the Premium?

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  • Ms. Eva Jenkner
  • Zhongjin Lu

Abstract

Studies have shown that markets may underprice sub-national governments’ risk on the implicit assumption that these entities would be bailed out by their central government in case of financial difficulties. However, the question of whether sovereigns pay a premium on their own borrowing as a result of (implicitly or explicitly) guaranteeing sub-entities’ debt has been explored only little. We use an event study approach with separate equations for two levels of government to test for a simultaneous increase in sovereign risk premia and decrease in sub-national risk premia—or a de facto transfer of risk from the latter to the former—on the day a sovereign bailout is announced. Using daily financial market data for Spain and its autonomous regions from January 2010 to June 2013, we find support for our risk transfer hypothesis. We estimate that the Spanish sovereign’s spread may have increased by around 70 basis points as a result of the central government’s support for fiscally distressed comunidades autónomas.

Suggested Citation

  • Ms. Eva Jenkner & Zhongjin Lu, 2014. "Sub-National Credit Risk and Sovereign Bailouts: Who Pays the Premium?," IMF Working Papers 2014/020, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2014/020
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    2. Sola, Sergio & Palomba, Geremia, 2016. "Sub-nationals' risk premia in fiscal federations: Fiscal performance and institutional design," Journal of International Money and Finance, Elsevier, vol. 63(C), pages 165-187.
    3. Beck, Roland & Ferrucci, Gianluigi & Hantzsche, Arno & Rau-Göhring, Matthias, 2017. "Determinants of sub-sovereign bond yield spreads – The role of fiscal fundamentals and federal bailout expectations," Journal of International Money and Finance, Elsevier, vol. 79(C), pages 72-98.
    4. Hattori, Takahiro & Miyake, Hiroki, 2015. "Empirical Analysis of Yield Determinants in Japan’s Municipal Bond Market: Does Credit Risk Premium Exist?," MPRA Paper 67127, University Library of Munich, Germany.
    5. Cristiana Fiorelli & Nicola Pontarollo & Carolina Serpieri, 2022. "Legislative interventions for the Italian local public financial distress," Working Papers in Public Economics 219, University of Rome La Sapienza, Department of Economics and Law.
    6. Gürtler, Marc & Neelmeier, Philipp, 2018. "Empirical analysis of the international public covered bond market," Journal of Empirical Finance, Elsevier, vol. 46(C), pages 163-181.
    7. Mitu Gulati & Ugo Panizza & W Mark C Weidemaier & Gracie Willingham, 0. "When Governments Promise to Prioritize Public Debt: Do Markets Care?," Journal of Financial Regulation, Oxford University Press, vol. 6(1), pages 41-74.
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    10. Santiago José Pérez-Balsalobre & Carlos Llano-Verduras, 2021. "Modelling sovereign debt ratings for sub-national governments: the case of Spain before and after the crisis," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 48(2), pages 373-395, May.
    11. Mr. Sergio Sola & Mr. Geremia Palomba, 2015. "Sub-National Government’s Risk Premia: Does Fiscal Performance Matter?," IMF Working Papers 2015/117, International Monetary Fund.
    12. Mitze, Timo & Matz, Florian, 2015. "Public debt and growth in German federal states: What can Europe learn?," Journal of Policy Modeling, Elsevier, vol. 37(2), pages 208-228.
    13. András Bethlendi & Csaba Lentner, 2018. "Subnational Fiscal Consolidation: The Hungarian Path from Crisis to Fiscal Sustainability in Light of International Experiences," Sustainability, MDPI, vol. 10(9), pages 1-16, August.

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