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Local Currency Sovereign Risk

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  • WENXIN DU
  • JESSE SCHREGER

Abstract

We introduce a new measure of emerging market 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 lower sensitivity to global risk factors. We discuss several major sources of credit spread differentials, including positively correlated credit and currency risk, selective default, capital controls, and various financial market frictions.

Suggested Citation

  • Wenxin Du & Jesse Schreger, 2016. "Local Currency Sovereign Risk," Journal of Finance, American Finance Association, vol. 71(3), pages 1027-1070, June.
    • Handle: RePEc:bla:jfinan:v:71:y:2016:i:3:p:1027-1070
    DOI: 10.1111/jofi.12389
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