Artículos con la etiqueta ‘Risk Management (q-fin.RM); Statistical Finance (q-fin.ST)’

The European debt crisis: Defaults and market equilibrium

Por • 12 oct, 2012 • Category: Economía

During the last two years, Europe has been facing a debt crisis, and Greece has been at its center. In response to the crisis, drastic actions have been taken, including the halving of Greek debt. Policy makers acted because interest rates for sovereign debt increased dramatically. High interest rates imply that default is likely due to economic conditions. High interest rates also increase the cost of borrowing and thus cause default to be likely. If there is a departure from equilibrium, increasing interest rates may contribute to—rather than be caused by—default risk. Here we build a quantitative equilibrium model of sovereign default risk that, for the first time, is able to determine if markets are consistently set by economic conditions. We show that over the period 2001-2012, the annually-averaged long-term interest rates of Greek debt are quantitatively related to the ratio of debt to GDP. The relationship shows that the market consistently expects default to occur if the Greek debt reaches twice the GDP.