*Corresponding author, Deutsche Bundesbank, Economic Research Centre and University of Pittsburgh, European Union Center, Wilhelm-Epstein-Str. 14, 60431 Frankfurt, guntram.wolff@gmx.de. We thank Markus Kolb for providing us with the capital market data, André Harms for relevant information in detail on these data, and Alexander Schulz for significant help with the liquidity measure. Ben Craig, Jürgen Hamker, Wolfgang Lemke, Heinz Herrmann, Alexander Schulz, Dan Stegarescu and Karsten Wendorff, seminar participants at the Verein für Socialpolitik and the Max Planck Institute for research on collective goods provided invaluable comments and discussions. Remaining errors are ours. The opinions expressed in this paper do not necessarily represent the views of the Deutsche Bundesbank or its staff.
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Moral Hazard and Bail-Out in Fiscal Federations: Evidence for the German Länder
Article first published online: 17 JUL 2008
DOI: 10.1111/j.1467-6435.2008.00411.x
© 2008 The Authors. Journal compilation © 2008 Blackwell Publishing Ltd
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How to Cite
Heppke-Falk, K. H. and Wolff, G. B. (2008), Moral Hazard and Bail-Out in Fiscal Federations: Evidence for the German Länder. Kyklos, 61: 425–446. doi: 10.1111/j.1467-6435.2008.00411.x
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*Corresponding author, Deutsche Bundesbank, Economic Research Centre and University of Pittsburgh, European Union Center, Wilhelm-Epstein-Str. 14, 60431 Frankfurt, guntram.wolff@gmx.de. We thank Markus Kolb for providing us with the capital market data, André Harms for relevant information in detail on these data, and Alexander Schulz for significant help with the liquidity measure. Ben Craig, Jürgen Hamker, Wolfgang Lemke, Heinz Herrmann, Alexander Schulz, Dan Stegarescu and Karsten Wendorff, seminar participants at the Verein für Socialpolitik and the Max Planck Institute for research on collective goods provided invaluable comments and discussions. Remaining errors are ours. The opinions expressed in this paper do not necessarily represent the views of the Deutsche Bundesbank or its staff.
Publication History
- Issue published online: 17 JUL 2008
- Article first published online: 17 JUL 2008
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SUMMARY
We identify investor moral hazard in the German fiscal federation. Our identification strategy is based on a variable, which was used by the German Federal Constitutional Court as an indicator to determine eligibility of two German states (Länder) to a bail-out, the interest payments-to-revenue ratio. While risk premia measured in the German sub-national bond market react significantly to the relative debt level of a state (Land), we also find that a larger interest payments-to-revenue ratio counter-intuitively lowers risk premia significantly. Furthermore, with increasing values the risk premia decrease more strongly. This is evidence of investor moral hazard, because a larger indicator value increases the likelihood of receiving a bail-out payment. Our findings are robust to a variety of sample changes. In addition, we provide a case study of the recent Federal Constitutional Court ruling on the Land Berlin, which had filed for additional federal funds. The negative response of the court did not lead to a change in financial markets' bail-out expectations. In sum, our results indicate significant investor moral hazard in the sub-national German bond market.