Sovereigns at Risk: A Dynamic Model of Sovereign Debt and Banking Leverage
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Chapter in forthcoming NBER book NBER International Seminar on Macroeconomics 2019, Kristin Forbes and Pierre-Olivier Gourinchas, organizers
This paper develops a dynamic model with heterogeneous investors and sovereign default to analyze the dynamic link between banking sector capitalization and sovereign bond yields. The banking sector is modelled as operating under a Value-at-Risk (VaR) constraint, which can bind occasionally. As default risk rises, the constraint may bind, generating a fall in demand for sovereign bonds that can be accompanied by a rise in the risk premium if other agents are more risk averse. In turn, the rise in risk premium leads to a feedback effect through debt accumulation dynamics and the probability of government default.This chapter is not currently available on-line.
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Document Object Identifier (DOI): https://doi.org/10.1016/j.jinteco.2020.103298