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Local Currency Sovereign Risk

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  • Wenxin Du
  • Jesse Schreger

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

  • Wenxin Du & Jesse Schreger, 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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    More about this item

    Keywords

    Local currency; sovereign debts; currency swaps;
    All these keywords.

    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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