Why Prices Don't Respond Sooner to a Prospective Sovereign Debt Crisis

37 Pages Posted: 22 Mar 2015

See all articles by R. Braun

R. Braun

Federal Reserve Bank of Atlanta

Tomoyuki Nakajima

University of Tokyo

Date Written: November 2011

Abstract

We compare the dynamics of inflation and bond yields leading up to a sovereign debt crisis in settings where asset markets are frictionless to other settings with financial frictions. As compared with the case with frictionless asset markets, an asset market structure with financial frictions generates a significant delay in the response of prices to news about a future debt crisis. With complete markets, prices jump in response to news about the possibility of a future debt crisis. However, when short selling of government bonds is restricted, some agents can't act on their beliefs, and prices don't respond to the news. Instead, prices only move in periods immediately prior the crisis.

Keywords: sovereign debt crisis, deflation, fiscal risk, leverage, borrowing constraint

JEL Classification: E31, E62, H60

Suggested Citation

Braun, R. and Nakajima, Tomoyuki, Why Prices Don't Respond Sooner to a Prospective Sovereign Debt Crisis (November 2011). FRB Atlanta Working Paper No. 2011-13, Available at SSRN: https://ssrn.com/abstract=2479593 or http://dx.doi.org/10.2139/ssrn.2479593

R. Braun (Contact Author)

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

Tomoyuki Nakajima

University of Tokyo ( email )

Yayoi 1-1-1
Bunkyo-ku
Tokyo, Tokyo 113-8657
Japan

HOME PAGE: http://https://sites.google.com/view/tomoyukinakajima/home

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