Real Economic Shocks and Sovereign Credit Risk

60 Pages Posted: 23 Nov 2010 Last revised: 1 Mar 2017

Patrick Augustin

McGill University, Desautels Faculty of Management

Roméo Tédongap

ESSEC Business School Paris-Singapore

Date Written: 2014

Abstract

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

Augustin, Patrick and Tédongap, Roméo, Real Economic Shocks and Sovereign Credit Risk (2014). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1713454 or http://dx.doi.org/10.2139/ssrn.1713454

Patrick Augustin

McGill University, Desautels Faculty of Management ( email )

1001 Sherbrooke Street West
Quebec
Montreal, Quebec H3A 1G5
Canada

HOME PAGE: http://www.patrickaugustin.se

Roméo Tédongap (Contact Author)

ESSEC Business School Paris-Singapore ( email )

Avenue Bernard Hirsch
BP 105 Cergy Cedex, 95021
France
+33134439734 (Phone)
+33134439734 (Fax)

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