Mispricing of debt expansion in the eurozone sovereign credit market

84 Pages Posted: 13 Feb 2020 Last revised: 24 Feb 2023

See all articles by Somayyeh Lotfi

Somayyeh Lotfi

University of Cyprus - Department of Accounting and Finance

Andreas Milidonis

University of Cyprus - Department of Accounting and Finance

Stavros A. Zenios

University of Cyprus; Bruegel; University of Pennsylvania - Wharton Financial Institutions Center; Cyprus Academy of Sciences, Letters, and Arts

Date Written: March 30, 2021

Abstract

We find evidence consistent with risk mispricing in the eurozone sovereign credit market for crisis and non-crisis countries alike, using a novel variable of sovereign debt expansion (DE) that we construct. Even though DE predicts increased default probability, panel regressions from 2002–2017 show a negative association with premia, even when controlling for risk appetite and the known determinants of sovereign premia. The negative association is only briefly interrupted by the 2010 Deauville Summit as expected, but it resumes by the onset of the 2011 eurozone crisis. The introduction of quantitative easing in 2015 mutes the negative association, therefore raising the
concern of what will happen once quantitative easing ends. Our finding is robust to several model specifications.

Keywords: CDS spreads, risk premia, debt expansion, sovereign debt, Quantitative easing.

JEL Classification: E52, E58, G41, H30, H63

Suggested Citation

Lotfi, Somayyeh and Milidonis, Andreas and Zenios, Stavros A., Mispricing of debt expansion in the eurozone sovereign credit market (March 30, 2021). Available at SSRN: https://ssrn.com/abstract=3533715 or http://dx.doi.org/10.2139/ssrn.3533715

Somayyeh Lotfi

University of Cyprus - Department of Accounting and Finance ( email )

Cyprus

Andreas Milidonis

University of Cyprus - Department of Accounting and Finance ( email )

P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 22 893 626 (Phone)

HOME PAGE: http://www.ucy.ac.cy/~amilidon/

Stavros A. Zenios (Contact Author)

University of Cyprus ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
Cyprus
+357 2 893605 (Phone)

HOME PAGE: http://https://www.researchgate.net/profile/Stavros_Zenios

Bruegel ( email )

Rue de la Charité 33
B-1210 Brussels Belgium, 1210
Belgium

University of Pennsylvania - Wharton Financial Institutions Center ( email )

3733 Spruce Street
Philadelphia, PA 19104-6374
United States

HOME PAGE: http://zenios.wordpress.com

Cyprus Academy of Sciences, Letters, and Arts ( email )

Nicosia
Cyprus

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