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Local Currency Sovereign Risk

  • Du, Wenxin

    ()

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

  • Schreger, Jesse

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

Registered author(s):

    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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    File URL: http://www.federalreserve.gov/pubs/ifdp/2013/1094/ifdp1094.pdf
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    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
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    Handle: RePEc:fip:fedgif:1094
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    18. Fletcher, Donna J & Taylor, Larry W, 1996. ""Swap" Covered Interest Parity in Long-Date Capital Markets," The Review of Economics and Statistics, MIT Press, vol. 78(3), pages 530-38, August.
    19. Wade D. Pfau, 2008. "Emerging Market Pension Funds and International Diversification," GRIPS Discussion Papers 08-10, National Graduate Institute for Policy Studies.
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    22. John D. Burger & Francis E. Warnock & Veronica Cacdac Warnock, 2010. "Emerging Local Currency Bond Markets," NBER Working Papers 16249, National Bureau of Economic Research, Inc.
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