Sovereign Default Risk and Firm Heterogeneity

68 Pages Posted: 10 Apr 2017 Last revised: 15 Sep 2021

See all articles by Cristina Arellano

Cristina Arellano

Federal Reserve Bank of Minneapolis

Yan Bai

University of Rochester - Department of Economics

Luigi Bocola

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: April 2017

Abstract

This paper measures the output costs of sovereign risk by combining a sovereign debt model with firm- and bank-level data. In our framework, an increase in sovereign risk lowers the price of government debt and has an adverse impact on banks’ balance sheets, disrupting banks’ ability to finance firms. Importantly, firms are not equally affected by these developments: those that have greater financing needs and borrow from banks that are more exposed to government debt cut their production the most in a debt crisis. We use Italian data to measure these firm-level elasticities and use them as empirical targets for estimating the structural model. In a counterfactual analysis, we find that heightened sovereign risk was responsible for one-third of the observed output decline during the Italian debt crisis.

Suggested Citation

Arellano, Cristina and Bai, Yan and Bocola, Luigi, Sovereign Default Risk and Firm Heterogeneity (April 2017). Available at SSRN: https://ssrn.com/abstract=2949638

Cristina Arellano (Contact Author)

Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Yan Bai

University of Rochester - Department of Economics ( email )

Harkness Hall
Rochester, NY 14627
United States

Luigi Bocola

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
STANFORD, CA 94305-6072
United States

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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