Neglected Risk: Evidence from the Eurozone Sovereign Credit Market

72 Pages Posted: 13 Feb 2020 Last revised: 3 Aug 2020

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

Date Written: February 7, 2020

Abstract

We find evidence of neglected risk during sovereign debt expansions (DE), by analyzing the sovereign credit market for both crisis and noncrisis Eurozone countries from 2002-2017. We show that whereas DE predicts increased default probability, large DE predict negative future risk premia. Using panel regressions with several control variables, including risk appetite, we then document a negative association between DE and risk premia. Using the shock of the Deauville summit in October 2010 we document its impact using panel regressions one year before and after the event, and find further evidence of neglected risk before but not immediately after Deauville. Finally, analyzing the most recent data (2011-2017) we show that DE still predicts lower risk premia, but this effect is neutralized by quantitative easing, raising the public policy question of what will happen with the end of quantitative easing.

Keywords: Risk premia, debt expansion, CDS spreads, sovereign debt, Deauville, Quantitative easing

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

Suggested Citation

Lotfi, Somayyeh and Milidonis, Andreas and Zenios, Stavros A., Neglected Risk: Evidence from the Eurozone Sovereign Credit Market (February 7, 2020). 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

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