Sovereign Bond Risk Premiums

Engelbert J. Dockner

WU Vienna University of Economics and Business

Manuel Mayer

Oesterreichische Nationalbank (OeNB)

Josef Zechner

Vienna University of Economics and Business

May 2013

Credit risk has become an important factor driving government bond returns. We therefore introduce an asset pricing model which exploits information contained in both forward interest rates and forward CDS spreads. Our empirical analysis covers euro-zone countries with German government bonds as credit risk-free assets. We construct a market factor from the first three principal components of the German forward curve as well as a common and a country-specific credit factor from the principal components of the forward CDS curves. We find that predictability of risk premiums of sovereign euro-zone bonds improves substantially if the market factor is augmented by a common and an orthogonal country-specific credit factor. While the common credit factor is significant for most countries in the sample, the country-specific factor is significant mainly for peripheral euro-zone countries. Finally, we find that during the current crisis period, market and credit risk premiums of government bonds are negative over long subintervals, a finding that we attribute to the presence of financial repression in euro-zone countries.

Number of Pages in PDF File: 53

Keywords: Bond risk premiums, market and credit risk factors, financial repression

JEL Classification: G12

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Date posted: June 9, 2013  

Suggested Citation

Dockner, Engelbert J. and Mayer, Manuel and Zechner, Josef, Sovereign Bond Risk Premiums (May 2013). Available at SSRN: https://ssrn.com/abstract=2275916 or http://dx.doi.org/10.2139/ssrn.2275916

Contact Information

Engelbert J. Dockner (Contact Author)
WU Vienna University of Economics and Business ( email )
Heiligenstaedter Strasse 46-48
Vienna, 1190
+431313366302 (Phone)
+43131336906302 (Fax)
HOME PAGE: http://www.wu.ac.at/finance/people/faculty/list/dockner
Manuel Mayer
Oesterreichische Nationalbank (OeNB) ( email )
Otto-Wagner-Platz 3, PO Box 61
1010 Vienna, A-1011
Josef Zechner
Vienna University of Economics and Business ( email )
Welthandelsplatz 1
Vienna, Wien A-1019

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