Uncertainty shocks and non-fundamental debt crises: An ambiguity approach

Konferenzbeitrag

This paper analyses empirically and theoretically the effects of uncertainty shocks on sovereign default risk. It describes a novel mechanism for non-fundamental debt crises induced by uncertainty shocks that are defined as time-varying levels of ambiguity surrounding the macroeconomic fundamental of the economy. A business cycle model with strategic sovereign default is augmented with ambiguity averse investors with multiple-priors utility. I find that uncertainty shocks increase the risk of default as perceived by worst case investors' beliefs. Sovereign and private sector interest rates rise due to a spillover channel that unfolds through the domestic banking sector. A crisis zone is characterised where worst case investors' beliefs lead to non-fundamental debt crises. The model's predictions are shown to be in line with impulse responses obtained from a VAR analysis for a panel of four Euro area countries. Specifically, the dichotomy of sovereign debt pricing in the core and periphery countries can partly be rationalised by accounting for ambiguity premia.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Beiträge zur Jahrestagung des Vereins für Socialpolitik 2015: Ökonomische Entwicklung - Theorie und Politik - Session: Banks, Debt, Financial Crises ; No. G04-V3

Classification and Topics

• Classification: Wirtschaft ; Criteria for Decision-Making under Risk and Uncertainty ; Financial Markets and the Macroeconomy ; International Lending and Debt Problems

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Große Steffen, Christoph
• Event: Veröffentlichung
• (when): 2015

Further information

• Handle: http://hdl.handle.net/10419/112936
• Last update: 10.03.2025, 11:42 AM CET