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Sovereigns at risk: A dynamic model of sovereign debt and banking leverage

Abstract : 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.
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https://halshs.archives-ouvertes.fr/halshs-02491806
Contributor : Caroline Bauer <>
Submitted on : Wednesday, February 26, 2020 - 1:39:20 PM
Last modification on : Tuesday, January 19, 2021 - 11:09:09 AM

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Nuno Coimbra. Sovereigns at risk: A dynamic model of sovereign debt and banking leverage. Journal of International Economics, Elsevier, 2020, 124, ⟨10.1016/j.jinteco.2020.103298⟩. ⟨halshs-02491806⟩

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