Sovereign Debt and Equity Returns in the Face of Disaster

Abstract

What makes an asset disaster resilient? We empirically study the role of sovereign debt for disaster resilience in a large global sample of firms. Using a novel firm-level measure of sovereign debt, we find that stocks with high (low) firm-level sovereign debt experience an increase (decrease) in their comovement with the global market portfolio in a disaster. This divergence in disaster betas demands a risk premium and high sovereign-debt firms earn higher returns in normal times. In a disaster, analysts turn more pessimistic and disagree more about the long-term earnings growth of high sovereign-debt firms. The results are robust to a host of firm characteristics, within the same headquarter country and industry, and to a broader measure of fiscal constraints. Our findings have important implications for disaster-based asset pricing models and suggest that fiscal constraints are a key driver of asset resilience.

Keywords: Sovereign debt, fiscal constraints, disaster, cross-sectional empirical asset pricing, long-term growth expectations

JEL Classification: F30, G12, G14, G15, H12, H50, H63