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Life insurers' business model has changed with the growth of insurance products with minimum return guarantees that are exposed to market and interest risks. The interest risk exposure of US and European insurers increased in the low-rate environments after the global financial crisis and the European sovereign debt crisis, respectively. The relative fragility of life insurers is highly persistent across the global financial crisis, the European sovereign debt crisis, and the COVID-19 crisis. European insurers with a higher share of liabilities with minimum return guarantees in 2016 had lower stock returns during the COVID-19 crisis.
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Debauchery and Original Sin: The Currency Composition of Sovereign Debt
We present a model that accounts for the “mystery of original sin”, and the surge in local currency borrowing by emerging economies in the recent decade. We quantitatively investigate the currency composition of sovereign debt in the presence of two types of limited enforcement frictions arising from a government’s monetary and debt policy: strategic currency debasement and default on sovereign debt. Local currency debt obligations act as a better consumption hedge against income shocks than foreign currency debt because their real value can be affected by monetary policy. However, this provides a government with more temptation to deviate from disciplined monetary policy, thus restricting borrowing in local currency more than in foreign currency. Our model predicts that a country with less credible monetary policy borrows mainly in foreign currency as a substitute for monetary credibility. An important extension demonstrates that in the presence of an expectational Phillips curve, local currency debt improves the ability of monetary policymakers to commit.
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- Award ID(s):
- 1918340
- PAR ID:
- 10350269
- Date Published:
- Journal Name:
- Journal of the European Economic Association
- Volume:
- 20
- Issue:
- 3
- ISSN:
- 1542-4766
- Page Range / eLocation ID:
- 1095-1144
- Format(s):
- Medium: X
- Sponsoring Org:
- National Science Foundation
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