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

Author Info

  • 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://www1.vwa.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
Date of revision:
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;

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. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  2. International Monetary Fund, 2012. "Are Rating Agencies Powerful? An Investigation Into the Impact and Accuracy of Sovereign Ratings," IMF Working Papers 12/23, International Monetary Fund.
  3. Paul Krugman, 1996. "Are Currency Crises Self-Fulfilling?," NBER Chapters, in: NBER Macroeconomics Annual 1996, Volume 11, pages 345-407 National Bureau of Economic Research, Inc.
  4. Arnoud W. A. Boot & Todd T. Milbourn, 2002. "Credit Ratings as Coordination Mechanisms," William Davidson Institute Working Papers Series 457, William Davidson Institute at the University of Michigan.
  5. Enrica Detragiache, 1996. "Rational Liquidity Crises in the Sovereign Debt Market; In Search of a Theory," IMF Working Papers 96/38, International Monetary Fund.
  6. Masson, Paul, 1999. "Contagion:: macroeconomic models with multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 587-602, August.
  7. Paul De Grauwe, 2011. "A Fragile Eurozone in Search of a Better Governance," CESifo Working Paper Series 3456, CESifo Group Munich.
  8. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
  9. De Grauwe, Paul & Ji, Yuemei, 2012. "Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone," CEPS Papers 6548, Centre for European Policy Studies.
  10. Alesina, Alberto F & Prati, Alessandro & Tabellini, Guido, 1989. "Public Confidence and Debt Management: A Model and a Case Study of Italy," CEPR Discussion Papers 351, C.E.P.R. Discussion Papers.
  11. 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.
  12. Mark A. Carlson & Galina B. Hale, 2005. "Courage to Capital? A Model of the Effects of Rating Agencies on Sovereign Debt Role-over," Cowles Foundation Discussion Papers 1506, Cowles Foundation for Research in Economics, Yale University.
  13. Bertrand Candelon & Amadou N. R. 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.
  14. Paul De Grauwe & Yuemei Ji, 2012. "Self-Fulfilling Crises in the Eurozone. An Empirical Test," CAMA Working Papers 2012-37, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  15. De Grauwe, Paul & Ji, Yuemei, 2012. "Self-Fulfilling Crises in the Eurozone: An Empirical Test," CEPS Papers 7085, Centre for European Policy Studies.
  16. Paul De Grauwe & Yuemei Ji, 2012. "Self-Fulfilling Crises in the Eurozone. An Empirical Test," CESifo Working Paper Series 3821, CESifo Group Munich.
  17. Andrew Hughes Hallett & Juan Carlos Martinez Oliva, 2012. "Global Imbalances in a World of Inflexible Real Exchange Rates and Capital Controls," Global Economic Review, Taylor & Francis Journals, vol. 41(4), pages 319-340, December.
  18. Gärtner, Manfred & Griesbach, Bjoern & Jung, Florian, 2011. "PIGS or Lambs? The European Sovereign Debt Crisis and the Role of Rating Agencies," Economics Working Paper Series 1106, University of St. Gallen, School of Economics and Political Science.
  19. Afonso, António & Gomes, Pedro & Rother, Philipp, 2007. "What “hides” behind sovereign debt ratings?," Working Paper Series 0711, European Central Bank.
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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
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Cited by:

  1. 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.
  2. Finn Marten Körner & Hans-Michael Trautwein, 2013. "Sovereign Credit Ratings and the Transnationalization of Finance - Evidence from a Gravity Model of Portfolio Investment," ZenTra Working Papers in Transnational Studies 20 / 2013, ZenTra - Center for Transnational Studies, revised Feb 2014.
  3. 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.
  4. Song, Edward, 2014. "Technical Innovations and Banking in a Quantum Economy," MPRA Paper 58456, University Library of Munich, Germany.
  5. 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.

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