Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt

48 Pages Posted: 9 Dec 2006 Last revised: 23 Oct 2009

Jens Hilscher

University of California, Davis

Yves Nosbusch

London School of Economics & Political Science (LSE)

Date Written: April 1, 2007

Abstract

This paper investigates the effects of macroeconomic fundamentals on emerging market sovereign credit spreads. We find that the volatility of terms of trade in particular has a statistically and economically significant effect on spreads. This is robust to instrumenting terms of trade with a country-specific commodity price index. Our measures of country fundamentals have substantial explanatory power, even controlling for global factors and credit ratings. We also estimate default probabilities in a hazard model and find that model implied spreads capture a significant part of the variation in observed spreads out-of-sample. The fit is better for lower credit quality borrowers.

Keywords: sovereign spreads, credit risk, bond pricing, terms of trade, default probabilities

JEL Classification: F34, G12, G13, G15

Suggested Citation

Hilscher, Jens and Nosbusch, Yves, Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt (April 1, 2007). EFA 2007 Ljubljana Meetings Paper. Available at SSRN: https://ssrn.com/abstract=687499 or http://dx.doi.org/10.2139/ssrn.687499

Jens Hilscher (Contact Author)

University of California, Davis ( email )

One Shields Avenue
Davis, CA 95616
United States

Yves Nosbusch

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

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