Events at CERGE-EI

Prof. Anton Braun

Federal Reserve Bank of Atlanta, USA

Authors: R. Anton Braun and Tomoyuki Nakajima

Abstract: Since 2008 actions have been taken in Europe and elsewhere that increase the cost of short-selling sovereign debt. We show that such actions can have a profound effect on the timing and magnitude of price responses to bad news in periods leading up to a sovereign default. When financial markets are frictionless, prices drop instantly in response to bad news even if the prospect of a crisis is very remote. Imposing costs on short-selling disrupts this dynamic. Government bond prices exhibit no response to bad news when the prospects are remote. Instead price declines only occur immediately prior to a sovereign default and then in a nonlinear way.

Keywords: sovereign debt crisis; bond prices; leverage; heterogenous beliefs.

JEL Classification numbers: E62, H60.

Full Text:  “Why Prices Don’t Respond Sooner to a Prospective Sovereign Debt Crisis”