Moral hazard and bail-out in fiscal federations: evidence for the German Länder

Arbeitspapier

We identify investor moral hazard in the German fiscal federation. Our identification strategy is based on a variable, which was used by the German Federal Constitutional Court as an indicator to determine eligibility of two German states (Länder) to a bail-out, the interest payments-to-revenue ratio. While risk premia measured in the German sub-national bond market react significantly to the relative debt level of a state (Land), we also find that a larger interest payments-to-revenue ratio counter-intuitively lowers risk premia significantly. Furthermore, with increasing values the risk premia decrease more strongly. This is evidence of investor moral hazard, because a larger indicator value increases the likelihood of receiving a bail-out payment. Quantitatively, the effects are, however, quite small. Our findings are robust to a variety of sample changes. In addition, we provide a case study of the recent Federal Constitutional Court ruling on the Land Berlin, which had filed for additional federal funds. The negative response of the court did not lead to a change in financial markets' bail-out expectations. In sum, our results indicate significant investor moral hazard in the sub-national German bond market.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Discussion Paper Series 1 ; No. 2007,07

Classification and Topics

• Classification: Wirtschaft ; International Lending and Debt Problems ; Information and Market Efficiency; Event Studies; Insider Trading ; International Financial Markets ; Fiscal Policy
• Subject: moral hazard ; bail-out ; sovereign bond spreads ; fiscal federalism ; Germany ; Länderfinanzen ; Öffentliche Schulden ; Öffentliche Anleihe ; Risikoprämie ; Finanzausgleich ; Moral Hazard ; Schätzung ; Deutschland ; Berlin

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Heppke-Falk, Kirsten H. ; Wolff, Guntram B.
• Event: Veröffentlichung
• (who): Deutsche Bundesbank
• (where): Frankfurt a. M.
• (when): 2007

Further information

• Handle: http://hdl.handle.net/10419/19684
• Last update: 10.03.2025, 11:43 AM CET