Ricerc@Sapienza

This study investigates the time-varying determinants of Italian sovereign risk using a Markov-switching structural vector autoregression, estimated on 1990–2018 monthly data. Sign restrictions are used for identification, and allow macroeconomic fundamentals and confidence-related factors to be characterized as separate and regime-dependent drivers of risk. We show that the latter becomes relevant during a crisis regime, when a negative confidence shock triggers demand-like macroeconomic disruptions, and sharp increases in sovereign spreads.

In this paper we aim to present a novel channel through which the volatility of the monetary/financial sector affects the instability of the real macroeconomic variables originated by self-fulfilling market sentiments. To this aim, we insert some elements of Prospect Theory in the preferences of agents living in an overlapping generations economy where consumers’heterogeneity and firms’imperfect information on the level of aggregate demand allow market sentiments to affect the equilibrium path of the economy under rational expectations.