Abstract
AbstractFiscal vulnerabilities depend on both the level and composition of government debt. This study examines the role of debt thresholds and debt composition in driving the nonlinear behaviour of long‐term interest rates through a novel approach, a panel smooth transition regression with a general logistic model. The main findings are threefold. First, the impact of the expected public debt level on interest rates rises exponentially when the share of foreign private holdings exceeds approximately 20% of government debt denominated in local currency. Second, if the public debt level exceeds a certain level, an increase in foreign private holding of government debt could raise interest rates, offsetting the downward pressure from higher market liquidity. Third, out‐of‐sample forecasts of this novel non‐linear model are more accurate than those of previous methods.
Highlights
As argued by Reinhart et al (2003), fiscal vulnerabilities depend on both the level and composition of government debt
As the impact of public debt on the interest rate of the generalized panel smooth transition regression (GPSTR) model continues to increase exponentially depending on the foreign private holdings ratio, an increase in foreign private holdings of government debt would cause a rise in long-term interest rates even the debt level is low
This study investigates the threshold values to understand the non-linear behavior of the long-term interest rate by developing a novel approach : a panel smooth transition regression with a general logistic model
Summary
As argued by Reinhart et al (2003), fiscal vulnerabilities depend on both the level and composition (foreign vs. domestic) of government debt. A large body of literature shows both positive and negative impacts of an increase in the share of foreign debt on government bond yields, a reconciliation of these opposite impacts through an investigation of the threshold has received less attention. To investigate such a threshold, the non-linear technique has not been examined well beyond a few studies. (ii) What is the threshold at which the level of public debt triggers a surge in government bond yields through the increase in the share of private foreign investors?.
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