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Title: Essays on fiscal policy and the pricing of sovereign debt
Author: Knox, Fraser William
ISNI:       0000 0004 5362 890X
Awarding Body: University of Strathclyde
Current Institution: University of Strathclyde
Date of Award: 2014
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This thesis consists of three essays which relate to the conduct of fiscal policy and the pricing of sovereign debt. The first chapter examines the credibility of official budgetary projections produced by the fiscal authorities of EU member states, as required under the provisions of the Stability and Growth Pact. Drawing upon existing studies, evidence is presented which demonstrates that these official projections are characterised by optimism bias, i.e. announced budgetary adjustments persistently falls short of those observed in practice. This chapter contributes to the existing literature by identifying a systematic link between the magnitude of this optimism bias and the degree of fragmentation which characterises the government: whereby greater fragmentation of this type coincides with a tendency to submit more optimistic projections. Numerical fiscal rules are then considered as a mechanism for improving the credibility of these projections and it shown that budgetary stric tures of this form have been effective in reducing the optimism bias which emerges when government fragmentation increases. The second chapter investigates the relative importance of systematic risk and conventional fiscal indicators in characterising the default risks of EMU member states and as potential explanations of pricing disparities which exist between public debt securities issued by these countries. Using both a portfolio approach and Fama and Macbeth cross-sectional regressions it is demonstrated that measures of systematic default risk (approximated by an issuer's default beta) and fiscal indicators overlap in the manner of risks which they represent. It is also shown that the common variation which exists between these alternate measures is relevant in explaining difference in the excess returns on EMU public debt securities in sample periods which both include and exclude the recent sovereign debt crisis. The third and final chapter uses a panel data model to examine yield spreads on ten-year public debt securities issued by EMU sovereign nations from 2005 to 2012. Existing studies have highlighted that there are (at times) substantial discrepancies between the spreads implied this class of model and the value of spreads observed in practice, particularly since the advent of the sovereign debt crisis in late 2009. Evidence of this nature has been used to substantiate arguments that financial markets have incorrectly priced the relative risks associated with these securities given that their prices cannot be related to an assumed fundamental basis. In this chapter I present an alternative account of evolutions in EMU yield spreads during the crisis which focuses upon the scale of macroeconomic imbalances characterising certain member states and their implications for public debt sustainability. It is shown that once these factors are taken into account up to 83% of the observed variation in yield spreads can be explained over this period. These results re-establish the importance of fundamentals in understanding market based perceptions of sovereign default risk during the crisis.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available