Abstract
Transactions costs associated with taking short positions on sovereign debt can have profound effects on government debt yields and the pattern of trade as a country moves toward default. To make this point we propose an equilibrium model of the sovereign debt market and fit the model to reproduce the dynamic path of 5-year Greek sovereign bond yields between 2008 and its credit event in 2012. We find that short-selling costs play a central role in accounting for the path of government bond yields and the pattern of movements in net credit default swap positions on Greek debt during this sample period.
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