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Sovereign Risk Premia
Nicola Borri Luiss University - Department of Economics Adrien Verdelhan MIT Sloan; National Bureau of Economic Research (NBER); Banque de France - Economic Study and Research Division February 15, 2009 AFA 2010 Atlanta Meetings Paper Abstract: Emerging countries tend to default when their economic conditions worsen. If bad times in an emerging country correspond to bad times for the US investor, then these foreign sovereign bonds are particularly risky and should offer high returns. We explore how this mechanism plays out in the data and in a general equilibrium model of optimal borrowing and default. Empirically, we obtain a cross-section of sovereign bond returns: The higher the correlation between past bond returns and US corporate default risk, the higher the average bond returns. A model of risk-averse lenders with external habit preferences replicates this feature.
Keywords: Sovereign debt, Asset pricing, Default risk JEL Classifications: F30, F34 Working Paper SeriesDate posted: February 17, 2009 ; Last revised: January 28, 2010Suggested CitationContact Information
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