Legal Risk Premia During the Euro-Crisis: The Role of Credit and Redenomination Risk

Jens Nordvig ()
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Jens Nordvig: Nomura Securities International, Inc., Postal: Worldwide Plaza, 309 West 49th Street, New York, NY 10019

No 10/2015, Discussion Papers on Economics from University of Southern Denmark, Department of Economics

Abstract: Using several new datasets, I document the role of legal risk premia in bond yields during the Euro-crisis. I find evidence of a rising premium especially in late 2011 and mid-2012 on bonds with foreign governing law relative to those with local governing law (and otherwise similar characteristics). The results illustrate that legal risk premia spiked at the height of the crisis in the Eurozone, when investors were willing to pay a premium for the additional protection offered by foreign law bonds. I show that this governing law premium can be linked to both credit risk (expected haircuts) and redenomination risk (expected currency depreciation). This paper is the first to empirically link the governing law premium to redenomination risk. I find evidence that redenomination risk is an independent driving force of governing law spreads over and above credit risk, although it is analytically challenging to separate the two risk factors. My findings, while not conclusive, are consistent with the consensus in the literature on contract law, which argues that local law financial instruments should be more susceptible to redenomination in a scenario of a country exiting the Eurozone.

Keywords: General financial markets; International finance; Foreign exchange; Contract law; Financial econometrics; Financial crisis (search for similar items in EconPapers)
JEL-codes: C58 F30 F31 G01 G10 K20 (search for similar items in EconPapers)
Pages: 79 pages
Date: 2015-05-21
New Economics Papers: this item is included in nep-eec and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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