Local Currency Sovereign Risk
71 Pages Posted: 30 May 2017
Date Written: 2013-12-10
Do governments default on debt denominated in their own currency? We introduce a new measure of sovereign credit risk, the local currency credit spread, defined as the spread of local currency bonds over the synthetic local currency risk-free rate constructed using cross currency swaps. We find that local currency credit spreads are positive and sizable. Compared with credit spreads on foreign currency denominated debt, local currency credit spreads have lower means, lower cross-country correlations, and are less sensitive to global risk factors. Global risk aversion and liquidity factors can explain more time variation in these credit spread differentials than macroeconomic fundamentals.
Keywords: Local currency, sovereign debt, currency swaps
JEL Classification: F31, F34, G15
Suggested Citation: Suggested Citation