The Asymmetric Pass-Through of Sovereign Risk


Money Macro Seminar

United States

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Abstract: This paper studies the macroeconomic effects of increases in corporate risk around sovereign debt crises. I use a heteroskedasticity-based approach to estimate the causal effect of sovereign risk on the credit risk of non-financial firms. Using Italian firm-level data for the last European debt crisis, I find that sovereign risk accounts for almost a third of the total increase in corporate risk and that this effect is stronger for riskier firms. I use bank-level data to show that the bank-lending channel plays an important role in this transmission. I find that banks with higher sovereign debt holdings exhibit a larger increase in their corporate non-performing loans. Increases in sovereign risk thus weaken banks' balance sheets directly, by decreasing the value of government bonds held by banks, and indirectly, through banks' exposures to non-financial firms. I formulate a heterogeneous-firms model where the banking sector transmits sovereign risk to firms and show it is able to match the empirical relationships estimated from Italian data. In a counterfactual analysis, I find that corporate risk represents a quantitatively important feedback mechanism that further deteriorates banks' balance sheets, amplifying the size and persistence of a sovereign debt crisis. I study different policies that can mitigate the negative effects of sovereign risk and identify efficiency gains from policies that exploit firms' heterogeneous reactions to increases in sovereign risk.

Matias Moretti

Matias Moretti

Visiting from Princeton University