36 Pages Posted: 3 Mar 2014 Last revised: 17 Nov 2014
Date Written: August 31, 2013
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: Suggested Citation