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Sovereign Default, Domestic Banks, and Financial Institutions

55 Pages Posted: 16 Mar 2012 Last revised: 13 Sep 2013

Nicola Gennaioli

Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Alberto Martin

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI); Centre for Economic Policy Research (CEPR)

Stefano Rossi

Bocconi University; Krannert School of Management; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: April 29, 2013

Abstract

We present a model of sovereign debt in which, contrary to conventional wisdom, government defaults are costly because they destroy the balance sheets of domestic banks. In our model, better financial institutions allow banks to be more leveraged, thereby making them more vulnerable to sovereign defaults. Our predictions: government defaults should lead to declines in private credit, and these declines should be larger in countries where financial institutions are more developed and banks hold more government bonds. In these same countries, government defaults should be less likely. Using a large panel of countries, we find evidence consistent with these predictions.

Keywords: Sovereign Risk, Capital Flows, Institutions, Financial Liberalization, Sudden Stops

JEL Classification: F34, F36, G15, H63

Suggested Citation

Gennaioli, Nicola and Martin, Alberto and Rossi, Stefano, Sovereign Default, Domestic Banks, and Financial Institutions (April 29, 2013). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2023428 or http://dx.doi.org/10.2139/ssrn.2023428

Nicola Gennaioli

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Alberto Martin

Universitat Pompeu Fabra - Centre de Recerca en Economia Internacional (CREI) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Stefano Rossi (Contact Author)

Bocconi University ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Krannert School of Management ( email )

West Lafayette, IN 47907-1310
United States

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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