Interest premium and external position: A state dependent approach

Using a broad sample of countries between 1980 and 2017, this paper re-examines the empirical relationship between sovereign yield spreads and the level of external indebtedness of advanced, emerging and less-developed economies in both normal and crisis periods. It finds a significant relationship that is much stronger during crisis periods and its strength decreases with the level of economic development. It also shows that this relationship is non-linear which is primarily driven by periods of financial crises. We carry out a number of robustness checks, which highlight issues related to sample composition, the definition of sovereign bond yield spreads and crisis events. In all checks, our results are largely unchanged. These findings have a number of implications with regard to the calibration of macroeconomic models and debt sustainability analysis.