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Sovereign Risk Premia

  • Adrien Verdelhan

    (MIT Sloan)

  • Nicola Borri

    (LUISS University)

Emerging countries tend to default when their economic conditions worsen. If bad times in an emerging country correspond to bad times for the US investor, then these foreign sovereign bonds are particularly risky and should offer high returns. We explore how this mechanism plays out in the data and in a general equilibrium model of optimal borrowing and default. Empirically, we obtain a cross-section of sovereign bond returns: the higher the correlation between past bond returns and US corporate default risk, the higher the average bond returns. A model of risk-averse lenders with external habit preferences can replicate this feature.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 1122.

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Date of creation: 2010
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Handle: RePEc:red:sed010:1122
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  30. Cristina Arellano & Ananth Ramanarayanan, 2006. "Default and the Term Structure in Sovereign Bonds," 2006 Meeting Papers 299, Society for Economic Dynamics.
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