Moral hazard and bail-out in fiscal federations: evidence for the German Länder

Kirsten H. Heppke-Falk and Guntram Wolff

No 2007,07, Discussion Paper Series 1: Economic Studies from Deutsche Bundesbank

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.

Keywords: moral hazard; bail-out; sovereign bond spreads; fiscal federalism; Germany (search for similar items in EconPapers)
JEL-codes: E62 F34 G14 G15 H6 H7 (search for similar items in EconPapers)
Date: 2007
New Economics Papers: this item is included in nep-eec, nep-mac and nep-pbe
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Citations: View citations in EconPapers (13)

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Related works:
Journal Article: Moral Hazard and Bail‐Out in Fiscal Federations: Evidence for the German Länder (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bubdp1:5561

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