Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt
48 Pages Posted: 9 Dec 2006 Last revised: 23 Oct 2009
Date Written: April 1, 2007
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
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