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Risk Aversion, Sovereign Bonds and Risk Premium

  • Ferhan Salman

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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File URL: http://www.tcmb.gov.tr/wps/wcm/connect/5abe1fe4-f0f0-4bd1-ac4a-4aba9a10343c/WP0514ENG.pdf?MOD=AJPERES&CACHEID=5abe1fe4-f0f0-4bd1-ac4a-4aba9a10343c
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Paper provided by Research and Monetary Policy Department, Central Bank of the Republic of Turkey in its series Working Papers with number 0514.

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Date of creation: 2005
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Handle: RePEc:tcb:wpaper:0514
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  1. Constantinides, George M, 1990. "Habit Formation: A Resolution of the Equity Premium Puzzle," Journal of Political Economy, University of Chicago Press, vol. 98(3), pages 519-43, June.
  2. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
  3. Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1991. "The Pure Theory of Country Risk," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 391-435 National Bureau of Economic Research, Inc.
  4. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  5. Rajnish Mehra & Edward C. Prescott, 2003. "The Equity Premium in Retrospect," NBER Working Papers 9525, National Bureau of Economic Research, Inc.
  6. Edwards, Sebastian, 1986. "The pricing of bonds and bank loans in international markets : An empirical analysis of developing countries' foreign borrowing," European Economic Review, Elsevier, vol. 30(3), pages 565-589, June.
  7. Daniel Cohen & Jeffrey Sachs, 1991. "Growth and External Debt Under Risk of Debt Repudiation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 437-472 National Bureau of Economic Research, Inc.
  8. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  9. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
  10. Rajnish Mehra, 2003. "The Equity Premium: Why is it a Puzzle?," NBER Working Papers 9512, National Bureau of Economic Research, Inc.
  11. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," Boston University - Institute for Economic Development 59, Boston University, Institute for Economic Development.
  12. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  13. Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2003. "Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why it Matters," NBER Working Papers 10036, National Bureau of Economic Research, Inc.
  14. Jeffrey Sachs, 1983. "Theoretical Issues in International Borrowing," NBER Working Papers 1189, National Bureau of Economic Research, Inc.
  15. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
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