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Local Currency Sovereign Risk

  • Wenxin Du
  • Jesse Schreger

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. We consider how cash flow, liquidity and global risk aversion factors explain the credit spread differentials.

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Paper provided by Harvard University OpenScholar in its series Working Paper with number 102321.

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Date of creation: Jan 2014
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Handle: RePEc:qsh:wpaper:102321
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  1. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates and the current account," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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  5. Reinhart, Carmen, 2008. "The Next (but not new) Frontier for Sovereign Default," MPRA Paper 11865, University Library of Munich, Germany.
  6. Marcio Gomes Pinto Garcia & Alexandre Lowenkron, 2005. "Cousin risks: the extent and the causes of positive correlation between country and currency risks," Textos para discussão 507, Department of Economics PUC-Rio (Brazil).
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  8. Burger, John D. & Warnock, Francis E., 2007. "Foreign participation in local currency bond markets," Review of Financial Economics, Elsevier, vol. 16(3), pages 291-304.
  9. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
  10. Popper, Helen, 1993. "Long-term covered interest parity: evidence from currency swaps," Journal of International Money and Finance, Elsevier, vol. 12(4), pages 439-448, August.
  11. Francis A. Longstaff & Jun Pan & Lasse H. Pedersen & Kenneth J. Singleton, 2011. "How Sovereign Is Sovereign Credit Risk?," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 75-103, April.
  12. 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.
  13. Jean-Luc Vila & Dimitri Vayanos, 2009. "A Preferred-Habitat Model of the Term Structure of Interest Rates," FMG Discussion Papers dp641, Financial Markets Group.
  14. Fletcher, Donna J. & Taylor, Larry W., 1994. "A non-parametric analysis of covered interest parity in long-date capital markets," Journal of International Money and Finance, Elsevier, vol. 13(4), pages 459-475, August.
  15. Adrien Verdelhan & Hanno Lustig, 2005. "The Cross-Section Of Foreign Currency Risk Premia And Consumption Growth Risk," Boston University - Department of Economics - Working Papers Series WP2005-019, Boston University - Department of Economics.
  16. McBrady, Matthew R. & Schill, Michael J., 2007. "Foreign currency-denominated borrowing in the absence of operating incentives," Journal of Financial Economics, Elsevier, vol. 86(1), pages 145-177, October.
  17. José-María Da-Rocha & Eduardo-Luis Giménez & Francisco-Xavier Lores, 2013. "Self-fulfilling crises with default and devaluation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 53(3), pages 499-535, August.
  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. 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.
  20. Araujo, Aloisio & Leon, Marcia & Santos, Rafael, 2013. "Welfare analysis of currency regimes with defaultable debts," Journal of International Economics, Elsevier, vol. 89(1), pages 143-153.
  21. Pfau, Wade Donald, 2009. "Emerging Market Pension Funds and International Diversification," MPRA Paper 19039, University Library of Munich, Germany.
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