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Bounding the productivity default shock : Evidence from the The European Sovereign Debt Crisis

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  • Alonso-Ortiz, Jorge
  • Colla, Esteban
  • Da-Rocha, Jose-Maria

Abstract

Interest rate spreads on sovereign debt were negatively correlated with the evolution of stock prices during The European Sovereign Debt Crisis. In particular, for a sample of 9 european countries there was a year (between 2009 and 2012) in which the correlation between stock prices and spreads was almost -1. We use this fact to estimate the upper bound of productivity default shocks using a continuous time structural model of default. At every instant the government maximizes expected tax revenues, where the only source of uncertainty is TFP, which follows a regime switching brownian motion. By estimating TFP regimes, to match interest rate spreads on sovereign debt and stock prices, we compute the ratio of the productivity if there was a default relative to the no default benchmark. This is a measure on how much productivity could countries loose at default. We found a robust negative relation between the costs of default and the probability of default. That is, financial markets incorporate into prices the risk of default immediately.

Suggested Citation

  • Alonso-Ortiz, Jorge & Colla, Esteban & Da-Rocha, Jose-Maria, 2014. "Bounding the productivity default shock : Evidence from the The European Sovereign Debt Crisis," MPRA Paper 59617, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:59617
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    References listed on IDEAS

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    More about this item

    Keywords

    Default; Sovereign Debt; Financial Markets; Productivity;
    All these keywords.

    JEL classification:

    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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