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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.))

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.

Suggested Citation

  • Du, Wenxin & Schreger, Jesse, 2013. "Local Currency Sovereign Risk," International Finance Discussion Papers 1094, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgif:1094
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    Cited by:

    1. Madalina Anghel & Aurel Diaconu & Marius Popovici, 2016. "Theoretical considerations regarding risk analysis models," Romanian Statistical Review Supplement, Romanian Statistical Review, vol. 64(9), pages 64-72, September.
    2. Madhusudan Mohanty & Kumar Rishabh, 2016. "Financial intermediation and monetary policy transmission in EMEs: What has changed post-2008 crisis?," BIS Working Papers 546, Bank for International Settlements.
    3. repec:spr:joecth:v:64:y:2017:i:4:d:10.1007_s00199-015-0939-y is not listed on IDEAS
    4. Mark Aguiar & Manuel Amador & Emmanuel Farhi & Gita Gopinath, 2014. "Sovereign Debt Booms in Monetary Unions," American Economic Review, American Economic Association, pages 101-106.
    5. Marcio Garcia & Tony Volpon, 2014. "DNDFs:a more efficient way to intervene in FX markets?," Textos para discussão 621, Department of Economics PUC-Rio (Brazil).
    6. Boris Hofmann & Ilhyock Shim & Hyun Song Shin, 2016. "Sovereign yields and the risk-taking channel of currency appreciation," BIS Working Papers 538, Bank for International Settlements.
    7. Jeanneret, Alexandre & Souissi, Slim, 2016. "Sovereign defaults by currency denomination," Journal of International Money and Finance, Elsevier, vol. 60(C), pages 197-222.
    8. Mark Aguiar & Manuel Amador & Emmanuel Farhi & Gita Gopinath, 2013. "Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises," NBER Working Papers 19516, National Bureau of Economic Research, Inc.
    9. Tomas Williams, 2017. "Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market," Working Papers 2017-12, The George Washington University, Institute for International Economic Policy.
    10. Jesse Schreger & Wenxin Du, 2014. "Sovereign Risk, Currency Risk, and Corporate Balance Sheets," Working Paper 209056, Harvard University OpenScholar.
    11. Plantin, Guillaume & Shin, Hyun Song, 0. "Exchange rates and monetary spillovers," Theoretical Economics, Econometric Society.
    12. Blaise Gadanecz & Ken Miyajima & Chang Shu, 2014. "Exchange rate risk and local currency sovereign bond yields in emerging markets," BIS Working Papers 474, Bank for International Settlements.
    13. Schumacher, Julian & Chamon, Marcos & Trebesch, Christoph, 2015. "Foreign Law Bonds: Can They Reduce Sovereign Borrowing Costs?," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113199, Verein für Socialpolitik / German Economic Association.
    14. Ulrich Volz & Dafe Florence & Dennis Essers, 2017. "Localising Sovereign Debt: The Rise of Local Currency Bond Markets in Sub-Saharan Africa," Working Papers 202, Department of Economics, SOAS, University of London, UK.
    15. 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, revised 04 May 2016.
    16. Wenxin Du & Joanne Im & Jesse Schreger, 2017. "The U.S. Treasury Premium," NBER Working Papers 23759, National Bureau of Economic Research, Inc.
    17. Kirill Shakhnov & Nicola Borri, 2017. "Limited Arbitrage in the Market for Local Currency Emerging Market Debt," 2017 Meeting Papers 737, Society for Economic Dynamics.
    18. Corradin, Stefano & Rodriguez-Moreno, Maria, 2016. "Violating the law of one price: the role of non-conventional monetary policy," Working Paper Series 1927, European Central Bank.
    19. Patricia Gómez-González, 2015. "Financial innovation in sovereign borrowing and public provision of liquidity," Working Papers 1511, Banco de España;Working Papers Homepage.
    20. Ludovit Odor & Pavol Povala, 2016. "Risk Premiums in Slovak Government Bonds," Discussion Papers Discussion Paper No. 3/20, Council for Budget Responsibility.
    21. Ken Miyajima & Madhusudan Mohanty & James Yetman, 2014. "Spillovers of US unconventional monetary policy to Asia: the role of long-term interest rates," BIS Working Papers 478, Bank for International Settlements.
    22. Ricardo Sabbadini, 2017. "Overcoming the Original Sin: Gains from Local Currency External Debt," Working Papers, Department of Economics 2017_27, University of São Paulo (FEA-USP).

    More about this item

    Keywords

    Local currency; sovereign debt; currency swaps;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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