Stéphanie Collet, Free University of Brussels

"A unified Italy? Sovereign debt and investor scepticism"

Abstract

Sovereign debt and default risk have always been considered as an important part of financial markets, but recently, they have been even more in the spotlight. Indeed, the sovereign debt crisis is currently on top of the political agenda in Europe and beyond. Italy’s unification in 1861 is the best historical case of sovereign debt integration offering a parallel with Europe sovereign debt. The unification of Italy provides historical clues to answer questions on contemporary sovereign debt integration.

This paper provides an empirical study of sovereign debt integration and analyses the evolution of sovereign debt prices when several countries merge to become a “unified country”, or when the probability of such an event exists. Based on an original database of pre-Italian Bonds, this paper shows the impact of Italy’s unification on the bond prices. Italy’s unification was a long lasting process. The analysis shows that prior to the unification in 1862, the bonds issued by the future parts of the kingdom reacted in an idiosyncratic way. Around the sovereign debt integration, the paper highlights a large risk increase for low-yields bonds. Using a break point analysis and a Bayesian Dynamic Factor Model, the paper proves that until late 1860s the financial market did not believe in Italy’s Unification.