Fiscal space and sovereign risk pricing in a currency union

► We examine how currency union membership affects sovereign risk pricing for eurozone countries given their fiscal space. ► We argue that it has offsetting effects on debt sustainability (possibility of transfers but constrained monetary policy). ► To control for fiscal space, we use a forward looking concept that works better than traditional indicators. ► We find that pre- (post-) crisis CDS and bond rates were below (above) those implied by eurozone members' fiscal space. ► Thus, when sovereign bailouts did not occur with the hoped-for alacrity, eurozone members were sharply penalized.