Liquidity Crises, Liquidity Lines and Sovereign Risk

Liquidity Crises, Liquidity Lines and Sovereign Risk

Title:

Liquidity Crises, Liquidity Lines and Sovereign Risk

Number:

15/36

Author(s):

Yasin Kürşat Önder

Language:

English

Date:

December 2015

Abstract:

This paper delivers a framework to quantitatively investigate the introduction of liquidity lines during a liquidity crisis. In an endogenous sovereign default model, I quantify the gains of arranging such lines by comparing simulations of the model with the simulations found when the government issues only non-state contingent bonds. I find that liquidity lines mitigate the borrowing costs and generate gains both for the government and its creditors. I also show that when the liquidity lines are introduced and the sovereign is committed not to exceed its mean debt-to-income ratio prior to liquidity lines being established, then the gains are significantly larger. These findings shed light on the current policy discussions for the utilization of liquidity lines.

Keywords:

Sovereign default, Liquidity shocks, Swap lines, Global safety nets, FCL, PLL

JEL Codes:

F30;F34

Liquidity Crises, Liquidity Lines and Sovereign Risk
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