Country and Currency Risk Premia in an Emerging Market

Abstract

The magnitude and determinants of credit and currency risks are topics of considerable importance. This paper uses data on peso- and dollar-denominated debt issued by the Mexican government to identify currency and country risk premia. We show that shoc ks in equity and debt market returns translate into long-term increases in the premium demanded by investors with respect to currency and country factors. Country and currency premia help explain equity returns and closed-end fund discounts. Additional evidence is provided showing that investors did not anticipate the magnitude or timing of the currency devaluation of December 1994 and the subsequent financial crisis.

JEL Classification: F31, G12, G15