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Real Economic Shocks and Sovereign Credit Risk

Published online by Cambridge University Press:  10 June 2016

Patrick Augustin  and
Roméo Tédongap
Patrick Augustin*
Affiliation:
patrick.augustin@mcgill.ca, McGill University, Desautels Faculty of Management, Montreal, Quebec H3A 1G5, Canada
Roméo Tédongap
Affiliation:
tedongap@essec.edu, ESSEC Business School, Cergy-Pontoise 95000, France.
*
*Corresponding author: patrick.augustin@mcgill.ca
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Abstract

We provide new empirical evidence that U.S. expected growth and consumption volatility are closely related to the strong comovement in sovereign spreads. We rationalize these findings in an equilibrium model with recursive utility for credit default swap (CDS) spreads. The framework links a reduced-form default process with country-specific sensitivity to expected growth and macroeconomic uncertainty. Exploiting the high-frequency information in the CDS term structure across 38 countries, we estimate the model and find parameters consistent with preference for early resolution of uncertainty. Our results confirm the existence of time-varying risk premia in sovereign spreads as compensation for exposure to common U.S. macroeconomic risk.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 2 , April 2016 , pp. 541 - 587
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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