Rules and risk in the Euro area

We show that stronger fiscal rules in Euro area members reduce sovereign risk premia, in particular in times of market stress. Using a unique data set of rules-based fiscal governance in EU member states, we estimate a model of sovereign spreads that are determined by the probability of default in interaction with the level of risk aversion. The legal base of the rules and their enforcement mechanisms are the most important dimensions of rules-based fiscal governance. •We estimate the impact of fiscal rules on sovereign spreads at different risk aversion levels.•We exploit a unique data set on rules-based fiscal governance in the Euro area.•We estimate a model of sovereign spreads determined by default probability and risk aversion.•We find that the spread-reducing effect of the rules is important especially during market stress.•The legal basis and enforcement mechanisms are the most important dimensions of fiscal rules.