Global Risk in Long-Term Sovereign Debt
78 Pages Posted: 13 Dec 2017 Last revised: 26 Mar 2021
Date Written: June 13, 2018
This paper focuses on emerging market government bonds issued in local currency with different maturities. Foreign investors face interest rate, currency, and credit risks. We consider the entire term structure of carry trade returns and find that, while the default premium does not contribute to carry trade strategies, the contribution of interest rate risk, captured by the term premium, is large and increases with maturity. We introduce default risk in an otherwise standard affine model; we show that the volatility of the permanent component of the SDFs must be different across emerging markets in order to match these stylized facts.
Keywords: local currency; carry trade; term premium
JEL Classification: F31, F34, G15
Suggested Citation: Suggested Citation