Sovereign Yields and the Risk-Taking Channel of Currency Appreciation

47 Pages Posted: 19 Jan 2016

See all articles by Boris Hofmann

Boris Hofmann

Bank for International Settlements (BIS) - Monetary and Economic Department

Ilhyock Shim

Bank for International Settlements (BIS)

Hyun Song Shin

Bank for International Settlements (BIS)

Date Written: January 2016

Abstract

Currency appreciation against the US dollar is associated with the compression of emerging market economy (EME) sovereign yields. We find that this yield compression is due to reduced risk premiums rather than expectations of interest rates already priced into forward rates. We explore a model which ties together dollar credit to EME corporates, sovereign tail risks and global investor portfolio adjustments driven by economic capital constraints. Consistent with our model, we find no empirical association between currency appreciation and sovereign spreads when we use the trade-weighted effective exchange rate that is unrelated to the US dollar.

Keywords: bond spread, capital flow, credit risk, emerging market, exchange rate

JEL Classification: G12, G15, G23

Suggested Citation

Hofmann, Boris and Shim, Ilhyock and Shin, Hyun Song, Sovereign Yields and the Risk-Taking Channel of Currency Appreciation (January 2016). BIS Working Paper No. 538. Available at SSRN: https://ssrn.com/abstract=2717692

Boris Hofmann (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Ilhyock Shim

Bank for International Settlements (BIS) ( email )

78F, Two International Finance Centre
8 Finance Street, Central
Hong Kong, n/a n/a
Hong Kong

HOME PAGE: http://www.bis.org/author/ilhyock_shim.htm

Hyun Song Shin

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

HOME PAGE: http://www.bis.org/author/hyun_song_shin.htm

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