Sub-National Credit Risk and Sovereign Bailouts: Who Pays the Premium?

 
Author/Editor: E. Jenkner ; Zhongjin Lu
 
Publication Date: January 30, 2014
 
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Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate
 
Summary: Studies have shown that markets may underprice sub-national governments’ risk on the implicit assumption that these entities would be bailed out by their central government in case of financial difficulties. However, the question of whether sovereigns pay a premium on their own borrowing as a result of (implicitly or explicitly) guaranteeing sub-entities’ debt has been explored only little. We use an event study approach with separate equations for two levels of government to test for a simultaneous increase in sovereign risk premia and decrease in sub-national risk premia—or a de facto transfer of risk from the latter to the former—on the day a sovereign bailout is announced. Using daily financial market data for Spain and its autonomous regions from January 2010 to June 2013, we find support for our risk transfer hypothesis. We estimate that the Spanish sovereign’s spread may have increased by around 70 basis points as a result of the central government’s support for fiscally distressed comunidades autónomas.
 
Series: Working Paper No. 14/20
Subject(s): Credit risk | Borrowing | Risk premium | Spain | Fiscal policy

 
English
Publication Date: January 30, 2014
ISBN/ISSN: 9781484398876/1018-5941 Format: Paper
Stock No: WPIEA2014020 Pages: 29
Price:
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