The Re-pricing of Sovereign Risks Following the Global Financial Crisis

Abstract

How strong has been the effect of the Global Financial Crisis (GFC) on systemic risk in sovereign bond markets? Was the increase in credit spreads relative to triple-A benchmarks which followed the GFC the result of higher sovereign default risk or the result of a re-pricing that reflected changes in broader market conditions and risk aversion? In this paper we examine the variations of the systemic components of sovereign spreads before and after the GFC by specifying a sovereign credit yield curve which relates sovereign yield spreads to credit ratings and global factors which affected sovereign spreads regardless of their rating. We use daily data of ten-year bond yields and ratings for 64 developed economies and emerging markets, covering the period from to . Our estimates suggest that sovereign risk premia increased significantly after the GFC with most of the increase due to a re-pricing of broader market risks rather than an increase in the quantity or price of sovereign risk per se. Global risk in the sovereign bond market is driven by variables that relate to investor confidence, volatility risk, central bank liquidity and the position and the slope of the yield curve in the US.

Keywords: Sovereign risk, Credit yield curve, Global financial crisis, Sovereign ratings

JEL Classification: C58,G12,G17,G24