Sovereign Risk Premia
LUISS Guido Carli University - Department of Economics
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
September 14, 2011
AFA 2010 Atlanta Meetings Paper
Emerging countries tend to default when their economic conditions worsen. If harsh economic conditions in an emerging country correspond to similar conditions for the U.S. investor, then foreign sovereign bonds are particularly risky. We explore how this mechanism impacts the data and influences a general equilibrium model of optimal borrowing and default. Empirically, the higher the correlation between past foreign bond and U.S. market returns, the higher the average sovereign excess returns. In the model, sovereign defaults and bond prices depend not only on the borrowers' economic conditions, but also on the lenders' time-varying risk-aversion.
Number of Pages in PDF File: 52
Keywords: Sovereign debt, Asset pricing, Default risk
JEL Classification: F30, F34, E43
Date posted: February 17, 2009 ; Last revised: September 14, 2011
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