Market Consequences of Sovereign Accounting Errors

This paper investigates the market consequences of sovereign accounting errors. Eurostat, a division of the European Commission, issues semiannual assessments of financial reports produced by the member states of the European Union (EU), and issues reservations that detail financial reporting errors when they have doubts on the quality of sovereign financial reporting. Using a sample covering 28 EU countries from 2004-2018, we find that Eurostat is more likely to issue reservations (i) to countries for which the differences between changes in public debt and public deficit are high relative to their Gross Domestic Product; (ii) to countries in worse economic conditions; and (iii) to countries in which central banks hold more sovereign bonds. Sovereign bond yields abnormally increase during the reservation announcement window, especially when reservations explicitly mention deficit or debt and when such impact is quantified. We also find that domestic holdings of sovereign debt increase after reservations.