Events

Speaker:

Professor Fred Seunghyun Maeng
Assistant Professor of Economics
Nanyang Technological University

Sovereign spreads are only partly sovereign. This paper studies how funding conditions faced by lenders shape sovereign lending. Using surveys on lender credit terms, we document new evidence of surges in spreads and volatility during funding stress. We then develop a sovereign default model in which risk-averse lenders finance leveraged bond positions subject to occasionally binding collateral constraints. The model features funding-state-contingent spread dynamics: funding stress shrinks funding capacity available to lenders and triggers binding constraints, yielding higher spreads (by 0.73% vs. 0.79% in the data) and volatility (by 0.82% vs. 0.54% in the data). Longer maturities provide some protection against funding stress by reducing refinancing needs, yet the vulnerability rises due to debt dilution.