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Structured Eurobonds

Author

Listed:
  • Christian Bauer
  • Bernhard Herz
  • Alexandra Hild

Abstract

This paper develops a market-based approach to implement so called Eurobonds, i.e. common sovereign debt securities of European Monetary Union (EMU) countries. By applying an asset-backed security (ABS) approach positive implications of a common bond can be achieved and negative incentives (e.g. moral hazard) can be prevented. Within an ABS structure a special purpose vehicle (SPV) buys a portfolio of EMU countries debt instruments (pooling) and then issues a set of subordinated Eurobonds with varying risk and rating (tranching). By pooling and tranching the default risk is concentrated in one part of the capital structure, resulting in a large share of less risky securities and overall risk premia reduction. A fraction of the cash flows from the SPV to the countries is diverted to a trust fund, which covers the first losses in case of a country default. By contrast to propositions on Eurobonds made so far, our proposal has one major advantage: All EMU countries can benefit from participating in the ABS-structure. These benefits are driven by the following reasons: Firstly, we only introduce partial liability (10 % of initial notional) instead of joint liability in order to limit moral hazard. Secondly, interest gains are distributed among all participating and not defaulting countries. Our simulation study shows that on average all EMU member states - both high rated and low rated countries - gain by taking part in a Eurobond ABS due to the implied diversification and tranching effects. Average savings range between 8 % and 33 % of the total credit amount. Nonetheless, in the worst case scenario, there is a probability of a disprofit ranging between 5.5 % and 0 %. In our simulation Germany and Greece represent the two opposite ends of the range and therefore serve as example in the discussion.

Suggested Citation

  • Christian Bauer & Bernhard Herz & Alexandra Hild, 2011. "Structured Eurobonds," Research Papers in Economics 2011-09, University of Trier, Department of Economics.
  • Handle: RePEc:trr:wpaper:201109
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    File URL: http://www.uni-trier.de/fileadmin/fb4/prof/VWL/EWF/Research_Papers/2011-09.pdf
    File Function: First version, 2011
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    References listed on IDEAS

    as
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    4. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2003. "The Unholy Trinity of Financial Contagion," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 51-74, Fall.
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    6. Sergio Mayordomo & Juan Ignacio Peña & Eduardo S. Schwartz, 2009. "Towards a Common European Monetary Union Risk Free Rate," NBER Working Papers 15353, National Bureau of Economic Research, Inc.
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    8. Bauer, Christian & Herz, Bernhard & Hoops, Stefan, 2008. "A Cheap Lunch for Emerging Markets: Removing International Financial Market Imperfections with Modern Financial Instruments," World Development, Elsevier, vol. 36(9), pages 1514-1530, September.
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    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Alexandra M. D. Hild & Bernhard Herz & Christian Bauer, 2016. "The European Stability Mechanism - bastion of calm or crisis accelerant?," Research Papers in Economics 2016-12, University of Trier, Department of Economics.
    2. repec:oup:ecpoli:v:32:y:2017:i:90:p:175-219. is not listed on IDEAS
    3. Alexander Erler & Stefan Hohberger, 2016. "Editor's Choice TARGET2: How Costly is Buying Time?," CESifo Economic Studies, CESifo, vol. 62(3), pages 491-505.
    4. Markus K. Brunnermeier & Sam Langfield & Marco Pagano & Ricardo Reis & Stijn Van Nieuwerburgh & Dimitri Vayanos, 2017. "ESBies: safety in the tranches," Economic Policy, CEPR;CES;MSH, vol. 32(90), pages 175-219.
    5. Esteves Rui Pedro & Tunçer Ali Coşkun, 2016. "Eurobonds Past and Present: A Comparative Review on Debt Mutualization in Europe," Review of Law & Economics, De Gruyter, vol. 12(3), pages 659-688, November.
    6. Herz, Bernhard & Bauer, Christian & Hild, Alexandra, 2016. "Designing the ESM—Who Profits, Who Pays?," Annual Conference 2016 (Augsburg): Demographic Change 145709, Verein für Socialpolitik / German Economic Association.

    More about this item

    Keywords

    Eurobonds; EMU; asset-backed securities (ABS); financial instruments; indebtedness;

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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