Neglected Risk: Evidence from the Eurozone Sovereign Credit Market

Abstract

We find evidence consistent with neglected risk 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 between DE
and premia. Risk neglect was briefly interrupted by the 2010 Deauville Summit, but
resumed by the onset of the 2011 Eurozone crisis. The introduction of quantitative
easing since 2015 has muted the impact of neglected risk, therefore raising the concern
of what will happen once quantitative easing ends.

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

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