52 Pages Posted: 17 Feb 2009 Last revised: 14 Sep 2011
Date Written: September 14, 2011
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.
Keywords: Sovereign debt, Asset pricing, Default risk
JEL Classification: F30, F34, E43
Suggested Citation: Suggested Citation
Borri, Nicola and Verdelhan, Adrien, Sovereign Risk Premia (September 14, 2011). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1343746 or http://dx.doi.org/10.2139/ssrn.1343746