Inelastic Demand Meets Optimal Supply of Risky Sovereign Bonds
This paper presents evidence of inelastic demand in the market for risky sovereign bonds and examines its interplay with government policies. The methodology combines bond-level evidence with a structural model featuring endogenous bond issuances and default risk. Empirically, the paper exploits monthly changes in the composition of a major bond index to identify flow shocks that shift the available bond supply and are unrelated to country fundamentals. The paper finds that a 1 percentage point reduction in the available supply increases bond prices by 33 basis points. Although exogenous, these shocks might influence government policies and expected bond payoffs. The paper identifies a structural demand elasticity by feeding the estimated price reactions into a sovereign debt model that isolates endogenous government responses. These responses account for a third of the estimated price reactions. By penalizing additional borrowing, inelastic demand acts as a commitment device that reduces default risk.
| Main Authors: | , , , , |
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| Format: | Working Paper biblioteca |
| Language: | English en_US |
| Published: |
Washington, DC: World Bank
2024-03-26
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| Subjects: | EMERGING MARKETS BOND INDEX, INELASTIC FINANCIAL MARKETS, INSTITUTIONAL INVESTORS, INTERNATIONAL CAPITAL MARKETS, SMALL OPEN ECONOMIES, SOVEREIGN DEBT, |
| Online Access: | http://documents.worldbank.org/curated/en/099556503262429115/IDU1ff661c041beb0143a21a16b1690f59425b69 https://hdl.handle.net/10986/41288 |
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