Increasing Contingent Guarantees: The Asymmetrical Effect on Sovereign Risk of Different Government Interventions
Research Institute of Applied Economics Working Paper 2019/14
41 Pages Posted: 25 Sep 2019
Date Written: September 17, 2019
Government interventions to support the financial institutions fall into two broad categories: direct interventions (which immediately increase the government’s financing needs) and off-balance-sheet contingent guarantees (which have no immediate impact on debt but will add to government debt as and when a loss materializes). If financial sector losses are independent of sovereign’s own risk, all else being equal, they must have the same effect on the sovereign’s risk profile, even though they impact the government balance sheet differently. In this paper, we study the nature and effectiveness of a government’s interventions on its own risk profile. Our findings suggest that direct assistance has a significantly large effect on sovereign risk, while the effect of contingent guarantees is statistically not significant, being significant only for the euro area founders. Controlling for government interventions, we also find that GDP, perceived government effectiveness, economic sentiment, size of the financial sector, and membership of the euro area reduce the sovereign risk, while asset concentration within the financial sector, unemployment and inflation have an adverse effect. Our findings support Bresciani and Cossaro (2016)’s claim that during the sovereign debt crisis, governments undertook complex financial operations to change the composition of their interventions towards contingent guarantees.
Keywords: sovereign risk, financial assistance, fiscal capacity, bailout, contingent guarantee
JEL Classification: G01, H63
Suggested Citation: Suggested Citation