Sovereign Default Risk and Bank Fragility in Financially Integrated

Centro de Documentación e Información Mtro. Jesús Silva Herzog CEDI
Sovereign Default Risk and Bank Fragility in Financially Integrated Economies. © NBER
INSTITUTO DE INVESTIGACIONES ECONÓMICAS, UNAM
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Patrick Bolton and Olivier Jeanne
Sovereign Default Risk and Bank Fragility in Financially Integrated Economies
NBER Working Paper No. 16899, March 2011
We analyze contagious sovereign debt crises in financially integrated economies. Under financial integration banks
optimally diversify their holdings of sovereign debt in an effort to minimize the costs with respect to an individual country's
sovereign debt default. While diversification generates risk diversification benefits ex ante, it also generates contagion ex
post. We show that financial integration without fiscal integration results in an inefficient equilibrium supply of government
debt. The safest governments inefficiently restrict the amount of high quality debt that could be used as collateral in the
financial system and the riskiest governments issue too much debt, as they do not take account of the costs of
contagion. Those inefficiencies can be removed by various forms of fiscal integration, but fiscal integration typically
reduce the welfare of the country that provides the "safe-haven" asset below the autarky level.
Palabras Clave: deuda soberana, integración financiera, fragilidad bancaria, política fiscal
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