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Inelastic Demand Meets Optimal Supply of Risky Sovereign Bonds
Author:
Matías Moretti
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Lorenzo Pandolfi
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German Villegas Bauer
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Sergio L. Schmukler https://isni.org/isni/0000000404811396 International Monetary Fund

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Tomás Williams
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Series:
IMF Working Papers
Volume/Issue:
Volume 2024: Issue 227
Language:
English
Publication Date:
01 Nov 2024
DOI:
https://doi.org/10.5089/9798400290411.001
ISBN:
9798400290411
ISSN:
1018-5941
Pages:
64
Keywords:
inelastic financial markets; institutional investors; international capital markets; sovereign debt; IMF working paper research Department; debt issuance; price reaction; convenience yield; default cost parameter; long-term debt; U.S. dollar; bond payoff; investor demand; bond characteristics-month; inelastic investor; bond price change; unit price; price movement; Bonds; Asset prices; Demand elasticity; Debt default; Sovereign bonds; Global
Legal-disclaimer:
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
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We present evidence of inelastic demand for risky sovereign bonds and explore its implications for optimal government debt policies. Using monthly changes in the composition of a major international bond index, we identify flow shocks unrelated to fundamentals that shift the available bond supply. From these shocks, we estimate an inverse demand elasticity of -0.30 and show that it increases with countries’ default risk. We formulate a sovereign debt model with endogenous default and inelastic investors, calibrated to our empirical estimates. By penalizing additional borrowing, an inelastic demand acts as a disciplining device that reduces default risk and bond spreads.
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Cover IMF Working Papers
IMF Working Papers
ISSN:
1018-5941
Publisher:
International Monetary Fund