Vortrag
Risk and Uncertainty in Sovereign Debt Markets

Christoph Grosse Steffen, Maximilian Podstawski

IAAE 2016 Annual Conference
Mailand, Italien, 22.06.2016 - 25.06.2016



Abstract:
We assess the relationship between macroeconomic uncertainty and risk aversion and their role for the pricing of sovereign debt. A theoretical model of sovereign default is used to tell apart the effects of risk aversion and uncertainty for bond prices. We find that investors' risk aversion is positively affected by an increase in uncertainty, indicating toward uncertainty constituting a root cause for changes in risk attitudes. Building a structural VAR, we decompose credit default swaps (CDS) for Spain and Italy into three shocks: fundamental risk, risk aversion and an uncertainty. We find that shocks to macroeconomic uncertainty (1) have a significant and economically relevant impact on sovereign financing premia, (2) account for a share in sovereign CDS of up to 25 basis points at the onset of the European sovereign debt crisis, quantitatively comparable to the effect of increased risk aversion during this period, and (3) significantly increase international investors' risk aversion, in line with the predictions of the theoretical model.