The Dynamic Pricing of Sovereign Risk in Emerging Markets: Fundamentals and Risk Aversion

Posted: 22 May 2019

See all articles by Eli M. Remolona

Eli M. Remolona

Bank for International Settlements (BIS) - Monetary and Economic Department

Michela Scatigna

Bank for International Settlements (BIS)

Eliza Wu

The University of Sydney - Business School; Financial Research Network (FIRN)

Date Written: October 30, 2007

Abstract

This paper introduces a new approach to pricing sovereign risk based on sovereign credit default swap (CDS) spreads. We estimate a dynamic market-based measure of sovereign risk and use it to decompose sovereign CDS spreads into expected losses from default and the market risk premia required by investors as compensation for default risk. Using a dynamic panel data model, we find that country-specific fundamentals primarily drive sovereign risk whilst global investors' risk aversion drives time variation in the risk premia. Consistent with this, we also find that the sovereign risk premia is more highly correlated than sovereign risk itself within emerging market regions. These results help us to explain the remarkable narrowing of emerging market spreads between 2002 and 2006 and to understand the pricing mechanism and channel of contagion for emerging debt markets.

Keywords: sovereign risk, default risk premia, risk aversion, credit default swaps, emerging market debt

JEL Classification: F30, F34, G12, G15

Suggested Citation

Remolona, Eli M. and Scatigna, Michela and Wu, Eliza, The Dynamic Pricing of Sovereign Risk in Emerging Markets: Fundamentals and Risk Aversion (October 30, 2007). Journal of Fixed Income, Vol. Spring, 2008. Available at SSRN: https://ssrn.com/abstract=966711 or http://dx.doi.org/10.2139/ssrn.966711

Eli M. Remolona (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

IFC 2 Bldg, 78/F
Central
Hong Kong
Hong Kong
+852 2982 7150 (Phone)
+852 2982 7123 (Fax)

Michela Scatigna

Bank for International Settlements (BIS) ( email )

Basel, 4002
Switzerland

Eliza Wu

The University of Sydney - Business School ( email )

University of Sydney
Darlington
Sydney, NSW 2006
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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