Ambiguity and time-varying risk aversion in sovereign debt markets

Arbeitspapier

This paper introduces changes in the level of ambiguity as a complementary source of time-varying risk aversion. We show in a consumption-based asset pricing model with simultaneously risky and ambiguous assets that a rise in the level of ambiguity raises investors' risk aversion. The effect is quantified in an application to European sovereign debt markets using a structural VAR to achieve identification in the data. We proxy for ambiguity using a measure of macroeconomic uncertainty and decompose empirically credit default swaps (CDS) for Spain and Italy into three shocks: fundamental default risk, risk aversion, and uncertainty. We find that shocks to uncertainty significantly increase international investors' risk aversion, accounting for about one fifth of its variation at a five week horizon, and have a significant and economically relevant impact on sovereign financing premia.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: DIW Discussion Papers ; No. 1602

Classification and Topics

• Classification: Wirtschaft ; Multiple or Simultaneous Equation Models: Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models ; Information, Knowledge, and Uncertainty: General ; Interest Rates: Determination, Term Structure, and Effects ; Financial Crises ; National Debt; Debt Management; Sovereign Debt
• Subject: Time-varying risk aversion ; Ambiguity ; Uncertainty ; Sovereign debt ; Identification via heteroscedasticity ; Maxmin

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Grosse Steffen, Christoph ; Podstawski, Maximilian
• Event: Veröffentlichung
• (who): Deutsches Institut für Wirtschaftsforschung (DIW)
• (where): Berlin
• (when): 2016

Further information

• Handle: http://hdl.handle.net/10419/144827
• Last update: 10.03.2025, 11:44 AM CET