Sovereign Overhang and the Integration of Equity and Credit Markets Around the World
67 Pages Posted: 21 May 2023
Date Written: May 15, 2023
Abstract
As governments around the world steadily assume greater financial risk, there is concern about the growing sovereign risk that overhangs the private sector. Using a sample of 2,430 firms in 52 countries, we find that firms’ equity and credit returns exhibit higher R2s and are more tightly integrated in environments with greater sovereign risk. As such, emerging economies often exhibit strong equity-credit integration despite severe impediments to arbitrage. We find that sovereign risk contributes to economic policy uncertainty, and sovereign-to-corporate spillover is weakened by strong legal institutions. Our results indicate that elevated sovereign risk drives information to be revealed through credit markets and dampens reactions to firm-level information events. Overall, this study finds that sovereign risk is an important common driving force in firms’ equity and credit returns.
Keywords: Equity-Credit Integration, Systematic Risk, Economic Development, Property Rights, Economic Policy Uncertainty
JEL Classification: G12, G14
Suggested Citation: Suggested Citation