How do government bond markets expect and affect states’ conflictual behaviors? Many assume that interstate disputes harm states’ credit; however, existing research on finance have sparingly investigated specifically through what channel international disputes disturb government bondholders and the extent of the effect. On the contrary, although government bonds have been used as primary means for states to finance disputes, most empirical studies on conflicts have not factored in the financial costs of disputes. My study delves into the questions of what role government bondholders play in international disputes, and how they constrain or give leeway to states’ conflictual behaviors. My study seeks to propose detailed criteria that rational bondholders use when they evaluate states’ credit risks when facing interstate disputes and to provide an overview of how government bonds could be an instrument of market power for the purpose of state security.
I analyze my theory of how government bondholders react to international disputes, by using a dataset of Militarized Interstate Dispute (MID) incidents and government bond yields of 25 countries, including 18 developed and 7 developing countries, for 1971—2010. My results of panel regressions show that investors do not always react negatively when they observe their bond issuer engaged in an international dispute. Instead, they evaluate the actual risk that the interstate dispute would impose on their bond investments, conditional on how likely a dispute is to escalate to war and the predicted outcome of potential war in case the parties in dispute go into war. Investors are prudent enough to show more sensitive reactions to major clashes than minor quibbles among states. Further, bondholders withdraw their investments only when they expect their bond issuer’s defeat in potential war or when they have difficulties predicting the outcomes of disputes. Moreover, states’ economic development status conditions bondholders’ risk assessments in the sense that investors have biased perceptions of the (in)capabilities of developing countries’ governments to deal with potential credit risks associated with international disputes. Bondholders respond more negatively to the interstate disputes in which developing countries are the parties than developed countries are, even though the disputes themselves have objectively similar prospects of escalation to war.
Next, I investigate how states’ borrowing as well as their interest rates lead to different outcomes of disputes in two ways: whether a dispute is likely to escalate into war and if not who will be winner of the dispute. While the amount of debt has contradictory effects on a state’s waging conflict, augmenting its win probability on the one hand, but increasing the burden of debt service, on the other hand, the level of borrowing costs contributes only to financial pressure on a state’s economy. My results of binomial and multinomial logistic regressions on MIDs and interest rates of 56 countries for 1816–2007 show that high interest rates suppress the likelihood of escalation to war as well as a state’s win probability in a dispute. On the contrary, states try to avoid developing into war as far as the amount of debt is bearable, but once it exceeds a certain level, states turn more aggressive and prefer escalating to war over staying in the bargaining process.