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Self-Fulfilling Debt Crises: A Quantitative Analysis

  • Luigi Bocola
  • Alessandro Dovis
American Economic Review
vol. 109, no. 12, December 2019
(pp. 4343-77)
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Abstract

This paper investigates the role of self-fulfilling expectations in sovereign bond markets. We consider a model of sovereign borrowing featuring endogenous debt maturity, risk-averse lenders, and self-fulfilling crises à la Cole and Kehoe (2000). In this environment, interest rate spreads are driven by both fundamental and nonfundamental risk. These two sources of risk have contrasting implications for the maturity structure of debt chosen by the government. Therefore, they can be indirectly inferred by tracking the evolution of debt maturity. We fit the model to Italian data and find that nonfundamental risk played a limited role during the 2008–2012 crisis.

Citation

Bocola, Luigi, and Alessandro Dovis. 2019. "Self-Fulfilling Debt Crises: A Quantitative Analysis." American Economic Review, 109 (12): 4343-77. DOI: 10.1257/aer.20161471

Additional Materials

JEL Classification

  • E43 Interest Rates: Determination, Term Structure, and Effects
  • E44 Financial Markets and the Macroeconomy
  • F34 International Lending and Debt Problems
  • G01 Financial Crises
  • G15 International Financial Markets
  • H63 National Debt; Debt Management; Sovereign Debt