The World Price of Credit Risk
56 Pages Posted: 27 Jun 2012 Last revised: 15 Sep 2012
Date Written: June 1, 2012
Global asset pricing models have failed to capture the cross section of country equity returns. Emerging markets display robust positive pricing errors and country-level characteristics play a role in pricing international equities. This paper offers a risk-based explanation for such asset pricing deviations. A world credit risk factor is significantly priced in the cross section of country equity returns. In its presence, the positive pricing errors in emerging markets disappear and country-level characteristics no longer play a role. The risk premium for exposure to the credit risk factor is 80 basis points per month and has increased in recent years.
Keywords: sovereign credit risk, credit rating, emerging markets, international asset-pricing, market efficiency
JEL Classification: G12, G14, G15
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