Working Paper: NBER ID: w13658
Authors: Francis A. Longstaff; Jun Pan; Lasse H. Pedersen; Kenneth J. Singleton
Abstract: We study the nature of sovereign credit risk using an extensive sample of CDS spreads for 26 developed and emerging-market countries. Sovereign credit spreads are surprisingly highly correlated, with just three principal components accounting for more than 50 percent of their variation. Sovereign credit spreads are generally more related to the U.S. stock and high-yield bond markets, global risk premia, and capital flows than they are to their own local economic measures. We find that the excess returns from investing in sovereign credit are largely compensation for bearing global risk, and that there is little or no country-specific credit risk premium. A significant amount of the variation in sovereign credit returns can be forecast using U.S. equity, volatility, and bond market risk premia.
Keywords: Sovereign Credit Risk; Credit Default Swaps; Global Financial Markets
JEL Codes: G12; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Global financial market variables (F30) | Sovereign credit spreads (F34) |
| Local economic conditions (R11) | Sovereign credit spreads (F34) |
| U.S. stock market returns (G17) | Sovereign credit spreads (F34) |
| High-yield bond spreads (G12) | Sovereign credit spreads (F34) |
| U.S. equity volatility (G17) | Sovereign credit returns (F34) |
| Bond market risk premia (G12) | Sovereign credit returns (F34) |
| Global risk premia (G19) | Sovereign credit returns (F34) |