Liquidity, government bonds and sovereign debt crises
Title: Liquidity, government bonds and sovereign debt crises
Author: MOLTENI, Francesco
Publisher: European University Institute
Series/Number: EUI MWP; 2019/02
This paper analyzes the Eurozone financial crisis through the lens of sovereign bond liquidity. Using novel data, I show that following the emergence of sovereign risk, repo haircuts on peripheral government bonds sharply increased during the crisis, reducing their liquidity and amplifying the rise in their yields. I study the impact of this liquidity shock on asset prices and aggregate activity in a general equilibrium model with financial frictions. The model confirms the rise in the required returns of illiquid government bonds, predicts a substantial drop in economic activity and provides an additional mechanism for the transmission of sovereign risk.
Subject: Repo; Haircuts; Liquidity shock; Funding constraint; E44; E58; G12; G15; G23
Type of Access: openAccess