How Do Global Investors Differentiate between Sovereign Risks? The New Normal versus the Old

23 Pages Posted: 26 Jan 2016

See all articles by Marlene Amstad

Marlene Amstad

The Chinese University of Hong Kong, Shenzhen

Eli M. Remolona

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

Jimmy Shek

Bank for International Settlements (BIS)

Date Written: January 2016

Abstract

When global investors go into emerging markets or get out of them, how do they differentiate between economies? Has this behaviour changed since the crisis of 2008 to reflect a "new normal"? We consider these questions by focusing on sovereign risk as reflected in monthly returns on credit default swaps (CDS) for 18 emerging markets and 10 developed countries. Tests for breaks in the time series of such returns suggest a new normal that ensued around October 2008 or soon afterwards. Dividing the sample into two periods and extracting risk factors from CDS returns, we find an old normal in which a single global risk factor drives half of the variation in returns and a new normal in which that risk factor becomes even more dominant. Surprisingly, in both the old and new normal, the way countries load on this factor depends not so much on economic fundamentals as on whether they are designated an emerging market.

Keywords: Emerging market, CDS, sovereign risk, risk factor, new normal, taper tantrum

JEL Classification: C38, F34, G11, G12, G15

Suggested Citation

Amstad, Marlene and Remolona, Eli M. and Shek, Jimmy, How Do Global Investors Differentiate between Sovereign Risks? The New Normal versus the Old (January 2016). BIS Working Paper No. 541. Available at SSRN: https://ssrn.com/abstract=2722580

Marlene Amstad (Contact Author)

The Chinese University of Hong Kong, Shenzhen ( email )

Eli M. Remolona

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

IFC 2 Bldg, 78/F
Central
Hong Kong
Hong Kong
+852 2982 7150 (Phone)
+852 2982 7123 (Fax)

Jimmy Shek

Bank for International Settlements (BIS) ( email )

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