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We quantify the sovereign-bank doom loop by using the 1999 Marmara earthquake as an exogenous shock leading to an increase in Turkey's default risk. Our theoretical model illustrates that for banks with higher exposure to government securities, a higher sovereign default risk implies lower net worth and tightening financial constraint. Our empirical estimates confirm the model's predictions, showing that the exogenous change in sovereign default risk tightens banks' financial constraints significantly for banks that hold a higher amount of government securities. The resulting tighter bank financial constraints translate into lower credit provision, suggesting that there is a significant balance-sheet channel in transmitting a higher sovereign default risk toward real economic activity. JEL classification: E32, F15, F36, O16 Key words: banking crisis, bank balance sheets, lending channel, public debt, credit supply, I Introduction Financial institutions play a pivotal role in supplying credit both to private sectors and sovereign governments. Lending to their own sovereigns increase the exposure of the domestic financial [...]

We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the COVID-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points (bp). We refine this analysis by constructing a sample of bonds-issued by the same set of companies--that differ in their SMCCF eligibility. A diff-in-diff analysis shows that both announcements had large effects on credit spreads, narrowing spreads by 20 bp on eligible bonds relative to their ineligible counterparts within the same set of issuers across the two announcement periods. The March 23 announcement also reduced bid-ask spreads 10 bp within 10 days of the announcement. By lowering credit spreads and improving liquidity, the April 9 announcement had an especially pronounced effect on 'fallen angels.' The actual purchases lowered credit spreads by an additional 5 bp and bid-ask spreads by 2 bp. These results confirm that the SMCCF made it easier for companies to borrow in the corporate bond market. JEL classification: E44, E58, G12, G14 Key words: COVID-19, credit market support facilities, regression discontinuity, diff-in-diff, event study, purchase effects, Working Paper 2020-18 September 2020 1 Introduction Confronted with a severe turmoil in financial markets, major central banks were in the front trenches of the policy response to the Covid-19 [...]

We document stylized facts about China's recent exchange rate policy for its currency, the renminbi (RMB). Our empirical findings suggest that a 'two-pillar policy' is in place, aiming to balance RMB index stability and exchange rate flexibility We then develop a tractable no-arbitrage model of the RMB under the two-pillar policy. Using derivatives data on the RMB and the U.S. dollar index, we estimate the model to assess financial markets' views about the fundamental exchange rate and sustainability of the policy. Our model is able to predict the modification of the two-pillar policy in May 2017, when a discretion-based 'countercyclical factor' was introduced for the first time. We also examine the model's ability to forecast RMB movements. JEL classification: F31, G12, G13, G15 Key words: exchange rate policy, two-pillar policy, managed float, Chinese currency, renminbi, RMB, central parity, RMB index, 1 Introduction How China manages its currency, the Renminbi or RMB, is one of the most consequential decisions in global financial markets. China has been the world's largest exporter since [...]

In this paper, we study the interplay between sovereign risk and global financial risk. We show that a substantial portion of the comovement among sovereign spreads is accounted for by changes in global financial risk. We construct bond-level sovereign spreads for dollar-denominated bonds issued by more than 50 countries from 1995 to 2020 and use various indicators to measure global financial risk. Through panel regressions and local projection analysis, we find that an increase in global financial risk causes a large and persistent widening of sovereign bond spreads. These effects are strongest when measuring global risk using the excess bond premium, which is a measure of the risk-bearing capacity of US financial intermediaries. The spillover effects of global financial risk are more pronounced for speculative-grade sovereign bonds. JEL classification: E43, E44, F33, G12 Key words: sovereign bonds, CDS, global financial risk, excess bond premium, global financial cycle https://doi.org/10.29338/wp2021-27, 1 Introduction In this paper, we study the interplay between sovereign risk and financial risk. In the increasingly interconnected world economy, global financial institutions play a more important role in [...]

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jinteco.2005.04.003 Byline: Martin Uribe (a)(b), Vivian Z. Yue (c) Keywords: Country risk premium; Business cycles; Small open economy Abstract: This paper attempts to disentangle the intricate relation linking the world interest rate, country spreads, and emerging-market fundamentals. It does so by using a methodology that combines empirical and theoretical elements. The main findings are: (1) US interest rate shocks explain about 20% of movements in aggregate activity in emerging economies. (2) Country spread shocks explain about 12% of business cycles in emerging economies. (3) In response to an increase in US interest rates, country spreads first fall and then display a large, delayed overshooting; (4) US-interest-rate shocks affect domestic variables mostly through their effects on country spreads; (5) The feedback from emerging-market fundamentals to country spreads significantly exacerbates business-cycle fluctuations. Author Affiliation: (a) Department of Economics, Duke University, Durham, NC 27708, United States (b) NBER, United States (c) Department of Economics, New York University, New York, NY 10003, United States Article History: Received 29 June 2004; Revised 28 February 2005; Accepted 19 April 2005

This paper analyzes how U.S. monetary policy affects the pricing of dollar‐denominated sovereign debt. We document that yields on dollar‐denominated sovereign bonds are highly responsive to U.S. monetary policy surprises—during both the conventional and unconventional policy regimes—and that the passthrough of unconventional policy to foreign bond yields is, on balance, comparable to that of conventional policy. In addition, a conventional U.S. monetary easing (tightening) leads to a significant narrowing (widening) of credit spreads on sovereign bonds issued by countries with a speculative‐grade credit rating but has no effect on the corresponding weighted average of bilateral exchange rates for a basket of currencies from the same set of risky countries; this indicates that an unanticipated tightening of U.S. monetary policy widens credit spreads on risky sovereign debt directly through the financial channel, as opposed to indirectly through the exchange rate channel. During the unconventional policy regime, yields on both investment‐ and speculative‐grade sovereign bonds move one‐to‐one with policy‐induced fluctuations in yields on comparable U.S. Treasuries. We also examine whether the response of sovereign credit spreads to US monetary policy differs between policy easings and tightenings and find no evidence of such asymmetry. [ABSTRACT FROM AUTHOR]