The European Safe Bonds (ESBies): a new security to manage sovereign risk and banking risk?

The idea of European Safe Bonds (ESBies) was proposed by Brunnemier et al. (2017) as a solution to the shortage of safe assets in the Eurozone. ESBies are sovereign bonds issued jointly by all Eurozone countries and backed by their combined creditworthiness, aimed to provide a safe asset for banks and investors in the Eurozone and serve as a tool for risk sharing and fiscal stabilization. However, the implementation of ESBies faces challenges such as political, legal, and constitutional obstacles, and a lack of unanimity among politicians and economists. This thesis briefly examines the limitations of pricing ESBies by analyzing the movements of CDS spreads of sovereign and banks and pricing a CDO portfolio using copulas and VaR comparisons. The concern of inaccurate reflection of credit risk and insufficient returns raises questions on the pricing of ESBies. The study concludes that tranching and diversification are essential properties for designing a safe bond, and highlights the importance of considering the credit risk, level of correlation, and tail dependence for pricing ESBies. ​