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Rating agencies, self-fulfilling prophecy and multiple equilibria? An empirical model of the European sovereign debt crisis 2009-2011

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Listed author(s):
  • Gärtner, Manfred

    ()

  • Griesbach, Björn

    ()

Abstract

We explore whether experiences during Europe's sovereign debt crisis support the notion that governments faced scenarios of self-fulfilling prophecy and multiple equilibria. To this end, we provide estimates of the effect of interest rates and other macroeconomic variables on sovereign debt ratings, and estimates of how ratings bear on interest rates. We detect a nonlinear effect of ratings on interest rates which is strong enough to generate multiple equilibria. The good equilibrium is stable, ratings are excellent and interest rates are low. A second unstable equilibrium marks a threshold beyond which the country falls into an insolvency trap from which it may only escape by exogenous intervention. Coefficient estimates suggest that countries should stay well within the A section of the rating scale in order to remain reasonably safe from being driven into eventual default.

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File URL: http://ux-tauri.unisg.ch/RePEc/usg/econwp/EWP-1215.pdf
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Paper provided by University of St. Gallen, School of Economics and Political Science in its series Economics Working Paper Series with number 1215.

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Length: 35 pages
Date of creation: Jun 2012
Handle: RePEc:usg:econwp:2012:15
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Keywords: Eurozone; crisis; sovereign debt; credit spreads; bond yields; rating agencies; multiple equilibria; self-fulfilling prophecy;

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Find related papers by JEL classification:
  • F3 - International Economics - - International Finance
  • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
  • H6 - Public Economics - - National Budget, Deficit, and Debt

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  1. Bertrand Candelon & Amadou N Sy & Rabah Arezki, 2011. "Sovereign Rating News and Financial Markets Spillovers; Evidence from the European Debt Crisis," IMF Working Papers 11/68, International Monetary Fund.
  2. Graciela Kaminsky & Sergio L. Schmukler, 2002. "Emerging Market Instability: Do Sovereign Ratings Affect Country Risk and Stock Returns?," World Bank Economic Review, World Bank Group, vol. 16(2), pages 171-195, August.
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  11. repec:kap:iaecre:v:17:y:2011:i:3:p:288-299 is not listed on IDEAS
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  20. Schumacher, Ingmar, 2014. "On the self-fulfilling prophecy of changes in sovereign ratings," Economic Modelling, Elsevier, vol. 38(C), pages 351-356.
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  22. Simone Manganelli & Guido Wolswijk, 2009. "What drives spreads in the euro area government bond market?," Economic Policy, CEPR;CES;MSH, vol. 24, pages 191-240, 04.
  23. Manfred Gärtner & Björn Griesbach & Florian Jung, 2011. "PIGS or Lambs? The European Sovereign Debt Crisis and the Role of Rating Agencies," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 17(3), pages 288-299, August.
  24. Beetsma, Roel & Giuliodori, Massimo & de Jong, Frank & Widijanto, Daniel, 2013. "Spread the news: The impact of news on the European sovereign bond markets during the crisis," Journal of International Money and Finance, Elsevier, vol. 34(C), pages 83-101.
  25. G. Ferri & L.-G. Liu & J. E. Stiglitz, 1999. "The Procyclical Role of Rating Agencies: Evidence from the East Asian Crisis," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 28(3), pages 335-355, November.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Ideen und Interessen
    by Tobias Straumann in Never mind the markets on 2012-07-31 04:00:32
  2. La rolo de la taksad-agentejoj en la eÅ­rokrizo
    by Riŝo in Riŝo's blog on 2012-08-01 07:25:47
  3. Lese-Tipps: spannende Hintergründe zur Finanzkrise
    by Steffen Greschner in x Politics on 2012-07-31 17:42:18
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:

  1. El-Shagi, Makram & von Schweinitz, Gregor, 2015. "The Joint Dynamics of Sovereign Ratings and Government Bond Yields," IWH Discussion Papers 4/2015, Halle Institute for Economic Research (IWH).
  2. Mevlud Islami & Paul Welfens, 2013. "Financial market integration, stock markets and exchange rate dynamics in Eastern Europe," International Economics and Economic Policy, Springer, vol. 10(1), pages 47-79, March.
  3. Körner, Finn Marten & Trautwein, Hans-Michael, 2015. "Sovereign credit ratings and the transnationalization of finance: Evidence from a gravity model of portfolio investment," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 9, pages 1-54.
  4. Gärtner, Manfred & Griesbach, Björn & Mennillo, Giulia, 2013. "The near-death experience of the Celtic Tiger: a model-driven narrative from the European sovereign debt crisis," Economics Working Paper Series 1321, University of St. Gallen, School of Economics and Political Science.
  5. El-Shagi, Makram, 2016. "Much ado about nothing: Sovereign ratings and government bond yields in the OECD," IWH Discussion Papers 22/2016, Halle Institute for Economic Research (IWH).
  6. Paolo Canofari & Giancarlo Marini & Giovanni Piersanti, 2015. "Expectations and systemic risk in EMU government bond spreads," Quantitative Finance, Taylor & Francis Journals, vol. 15(4), pages 711-724, April.
  7. Luitel, Prabesh & Vanpée, Rosanne & De Moor, Lieven, 2016. "Pernicious effects: How the credit rating agencies disadvantage emerging markets," Research in International Business and Finance, Elsevier, vol. 38(C), pages 286-298.
  8. Gibson, Heather D. & Hall, Stephen G. & Tavlas, George S., 2017. "Self-fulfilling dynamics: The interactions of sovereign spreads, sovereign ratings and bank ratings during the euro financial crisis," Journal of International Money and Finance, Elsevier, vol. 73(PB), pages 371-385.
  9. Heather D. Gibson & Stephen G. Hall & George S. Tavlas, 2014. "Doom-loops: The Role of Rating Agencies in the Euro Financial Crisis," Discussion Papers in Economics 14/16, Department of Economics, University of Leicester.
  10. Song, Edward, 2014. "Technical Innovations and Banking in a Quantum Economy," MPRA Paper 58456, University Library of Munich, Germany.

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