Sovereign Default Risk and the US Equity Market
94 Pages Posted: 5 Dec 2010 Last revised: 19 Nov 2018
Date Written: December 19, 2014
This paper develops an international asset-pricing model with defaultable firms and governments that demonstrates how sovereign credit risk in Europe affects US equity market prices. The risk of a sovereign debt crisis is a threat to economic growth that reduces the value of international equities and increases their volatility. The effect is strongest under adverse economic conditions, when firms are in financial distress. A structural estimation of the model shows that sovereign default risk helps explain the level and the dynamics of equity volatility in Europe and the US over the 1991-2013 period.
Keywords: Sovereign Debt, Volatility, Credit Risk, Asset Pricing, International Financial Markets
JEL Classification: F31, F34, G12, G13, G15
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