Working Paper: NBER ID: w27903
Authors: Timo Daehler; Joshua Aizenman; Yothin Jinjarak
Abstract: Can bad news about COVID-19 induce negative expectations on sovereign credit risks? We investigate the factors driving credit default swap (CDS) spreads of emerging market sovereigns around the outbreak of COVID-19. Using 2014-2019 data, we estimate a two-factor model of global and regional risks and then extrapolate the model-implied spreads for the period July 2019–June 2020. Intriguingly, the model initially predicts the realized spreads well but loses predictive accuracy during the COVID-19 pandemic. Fiscal space and oil-revenue dependence primarily drive the differences between the realized and predicted sovereign spreads. Our augmented-factor model indicates that the cumulative COVID-19 mortality rate growth is positively associated with the CDS spreads. The evidence suggests that the epidemiological deterioration can lower confidence in the sovereign credit markets due to the prospects of prolonged lockdowns and a slower GDP growth recovery. Our results also hold for a single regression of daily spread changes during 2014-2020.
Keywords: Sovereign CDS Spreads; COVID-19; Emerging Markets; Epidemiology; Economics
JEL Codes: F34; F36; F41; H12; H51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| COVID-19 dynamics (C69) | sovereign CDS spreads (F34) |
| country-specific factors (F29) | sovereign CDS spreads (F34) |
| cumulative mortality rates (J17) | sovereign CDS spreads (F34) |
| global-regional factors (R11) | sovereign CDS spreads (F34) |
| economic ramifications of lockdowns and oil price declines (F69) | sovereign CDS spreads (F34) |