Real Economic Shocks and Sovereign Credit Risk
60 Pages Posted: 23 Nov 2010 Last revised: 13 Apr 2020
Date Written: 2014
We provide new empirical evidence that U.S. expected growth and consumption volatility are closely related to the strong co-movement in sovereign spreads. We rationalize these findings in an equilibrium model with recursive utility for CDS spreads. The framework nests a reduced-form default process with country-specific sensitivity to expected growth and macroeconomic uncertainty. Exploiting the high-frequency information in the CDS term structure across 38 countries, we estimate the model and find parameters consistent with preference for early resolution of uncertainty. Our results confirm the existence of time-varying risk premia in sovereign spreads as compensation for exposure to common U.S. macroeconomic risk.
Keywords: Credit Default Swap Spreads, Generalized Disappointment Aversion, Sovereign Risk, Term Structure
JEL Classification: C5, E44, F30, G12, G15
Suggested Citation: Suggested Citation