Political Uncertainty, Credit Risk Premium and Default Risk

36 Pages Posted: 3 Mar 2014 Last revised: 17 Nov 2014

Date Written: August 31, 2013

Abstract

I empirically decompose sovereign credit spreads into a default-risk component and its associated (credit) risk premium and study the effect of political uncertainty on them. On average, credit risk premia account for 42 percent of the observed spreads in the European sovereign credit market. I find that a 10 percent increase in political uncertainty leads to a 3 percent increase in both components after a month. A regional-level analysis reveals heterogeneity in the response of sovereign risk to variations in political uncertainty. This work enriches the understanding of how macroeconomic forces drive variations in sovereign risk and introduces political uncertainty as a significant factor driving the European credit market.

Keywords: Political Uncertainty, Credit Risk Premium, Default Risk, Sovereign Debt Crisis

JEL Classification: G12, G13, G18

Suggested Citation

Manzo, Gerardo, Political Uncertainty, Credit Risk Premium and Default Risk (August 31, 2013). Available at SSRN: https://ssrn.com/abstract=2376608 or http://dx.doi.org/10.2139/ssrn.2376608

Gerardo Manzo (Contact Author)

AQR Capital Management ( email )

Greenwich, CT
United States

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