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Local Currency Sovereign Risk

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  • Du, Wenxin

    ()
    (Board of Governors of the Federal Reserve System (U.S.))

  • Schreger, Jesse

    (Board of Governors of the Federal Reserve System (U.S.))

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    Abstract

    Do governments default on debt denominated in their own currency? We introduce a new measure of sovereign credit risk, the local currency credit spread, defined as the spread of local currency bonds over the synthetic local currency risk-free rate constructed using cross currency swaps. We find that local currency credit spreads are positive and sizable. Compared with credit spreads on foreign currency denominated debt, local currency credit spreads have lower means, lower cross-country correlations, and are less sensitive to global risk factors. Global risk aversion and liquidity factors can explain more time variation in these credit spread differentials than macroeconomic fundamentals.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 1094.

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    Length: 69 pages
    Date of creation: 10 Dec 2013
    Date of revision:
    Handle: RePEc:fip:fedgif:1094

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    Keywords: Local currency; sovereign debt; currency swaps;

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    1. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
    2. Jens Hilscher & Yves Nosbusch, 2007. "Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt," Money Macro and Finance (MMF) Research Group Conference 2006 114, Money Macro and Finance Research Group, revised 24 Apr 2007.
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    18. Hanno Lustig & Adrien Verdelhan, 2006. "The Cross-Section of Foreign Currency Risk Premia and Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series WP2006-045, Boston University - Department of Economics.
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    Cited by:
    1. Aguiar, Mark & Amador, Manuel & Farhi, Emmanuel & Gopinath, Gita, 2014. "Sovereign Debt Booms in Monetary Unions," Scholarly Articles 12559514, Harvard University Department of Economics.
    2. Hale, Galina & Jones, Peter & Spiegel, Mark M., 2014. "The rise in home currency issuance," Working Paper Series 2014-19, Federal Reserve Bank of San Francisco.

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