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Rating agencies, self-fulfilling prophecy and multiple equilibria? : An empirical model of the European sovereign debt crisis 2009-2011

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abstract We explore whether experiences during Europe's sovereign debt crisis support the notion that governments faced scenarios of self-fulfilling prophecy and multiple equilibria. To this end, we provide estimates of the effect of interest rates and other macroeconomic variables on sovereign debt ratings, and estimates of how ratings bear on interest rates. We detect a nonlinear effect of ratings on interest rates which is strong enough to generate multiple equilibria. The good equilibrium is stable, ratings are excellent and interest rates are low. A second unstable equilibrium marks a threshold beyond which the country falls into an insolvency trap from which it may only escape by exogenous intervention. Coefficient estimates suggest that countries should stay well within the A section of the rating scale in order to remain reasonably safe from being driven into eventual default.

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type discussion paper (English)
   
keywords Eurozone, crisis, sovereign debt, credit spreads, bond yields, rating agencies, multiple
equilibria, self-fulfilling prophecy.
   
project The role of rating agencies in the Eurozone sovereign debt crisis
date of appearance 15-6-2012
issuing department Department of Economics
series of paper Economics Working Paper Series (2012-15)
publisher School of Economics and Political Science
page(s) 33
review not reviewed
   
profile area SEPS - Economic Policy
citation Gärtner, M., & Griesbach, B., Department of Economics (Eds.), (2012). Rating agencies, self-fulfilling prophecy and multiple equilibria?: An empirical model of the European sovereign debt crisis 2009-2011. Economics Working Paper Series, 2012-15: School of Economics and Political Science.