Risk Aversion, Sovereign Bonds and Risk Premium
This paper analyzes the risk premium associated with sovereign bonds. We use the Generalized Method of Moments to estimate the level of risk aversion that is implied by the demand for such bonds. We show that although sovereign bonds offer comparable returns to those of US Equities they command higher risk premiums. Second, we observe that in contrast to what is suggested by theory, risk aversion parameters differ for each country. We name this observation “The Sovereign Bond Premium Puzzle.” Moreover, we present that, as oppose to ones intiution, country fundamentals and default probability are not answers for this variation.
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