Sovereign Risk Premia and Global Macroeconomic Conditions
67 Pages Posted: 2 May 2018 Last revised: 1 Sep 2020
Date Written: August 31, 2020
We study how shifting global macroeconomic conditions affect sovereign bond prices. Bondholders earn premia for two sources of systematic risk: exposure to low-frequency changes in the state of the economy, as captured by expected macroeconomic growth and volatility, and exposure to higher-frequency macroeconomic shocks. Our model predicts that the first source, labeled “long-run macro risk”, is the primary driver of the level and the cross-sectional variation in sovereign bond premia. We find support for this prediction using sovereign bond return data for 43 countries. A long-short portfolio based on long-run macro risk earns 8.11% per year in our sample.
Keywords: Sovereign bonds, risk premium, consumption-based asset pricing, credit risk, macroeconomic conditions
JEL Classification: F34, G12, G13, G15, G32
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