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Breakup and Default Risks in the Great Lockdown

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Document pages: 78 pages

Abstract: In this paper, we exploit CDS quotes for contracts denominated in different currencies and with different default clauses to estimate the risk of a breakup of the Eurozone and the propagation of breakup and default risks. In a period including the large COVID-19 shock, we find that the risk of a Eurozone breakup is significant. In addition, we find that an increase in the redenomination risk in one country is associated with an increase in default premia and bond spreads in other Eurozone countries. Finally, we find that a sizeable fraction of the changes in the cost of insuring against redenomination and default reflects two additional factors: the first captures the expected euro depreciation conditional on redenomination, while the second captures liquidity premia.

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