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Title:Moral hazard and bail-out in fiscal federations: evidence for the German Länder PDF Logo
Authors:Heppke-Falk, Kirsten H.
Wolff, Guntram B.
Issue Date:2007
Series/Report no.:Discussion paper Series 1 / Volkswirtschaftliches Forschungszentrum der Deutschen Bundesbank 2007,07
Abstract:We identify investor moral hazard in the German fiscal federation. Our identification strategy is based on a variable, which was used by the German Federal Constitutional Court as an indicator to determine eligibility of two German states (Länder) to a bail-out, the interest payments-to-revenue ratio. While risk premia measured in the German sub-national bond market react significantly to the relative debt level of a state (Land), we also find that a larger interest payments-to-revenue ratio counter-intuitively lowers risk premia significantly. Furthermore, with increasing values the risk premia decrease more strongly. This is evidence of investor moral hazard, because a larger indicator value increases the likelihood of receiving a bail-out payment. Quantitatively, the effects are, however, quite small. Our findings are robust to a variety of sample changes. In addition, we provide a case study of the recent Federal Constitutional Court ruling on the Land Berlin, which had filed for additional federal funds. The negative response of the court did not lead to a change in financial markets' bail-out expectations. In sum, our results indicate significant investor moral hazard in the sub-national German bond market.
Subjects:moral hazard
bail-out
sovereign bond spreads
fiscal federalism
Germany
JEL:F34
H6
H7
G14
G15
E62
Document Type:Working Paper
Appears in Collections:Discussion Paper Series 1: Economic Studies, Deutsche Bundesbank

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