Hostname: page-component-669899f699-chc8l Total loading time: 0 Render date: 2025-04-28T22:37:08.285Z Has data issue: false hasContentIssue false
  • English
  • Français

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
Get access Rights & Permissions [Opens in a new window]

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 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

References

Acharya, V. V., and Johnson, T. C.. “Insider Trading in Credit Derivatives.” Journal of Financial Economics, 84 (2007), 110–141.CrossRefGoogle Scholar
Ang, A., and Longstaff, F. A.. “Systemic Sovereign Credit Risk: Lessons from the U.S. and Europe.” Journal of Monetary Economics, 60 (2013), 493–510.CrossRefGoogle Scholar
Arellano, C. “Default Risk and Income Fluctuations in Emerging Economies.” American Economic Review, 98 (2008), 690–712.CrossRefGoogle Scholar
Augustin, P. “The Term Structure of CDS Spreads and Sovereign Credit Risk.” Working Paper, McGill University (2016).Google Scholar
Backus, D. K.; Kehoe, P. J.; and Kydland, F. E.. “International Real Business Cycles.” Journal of Political Economy, 100 (1992), 745–775.CrossRefGoogle Scholar
Baek, I.-M.; Bandopadhyaya, A.; and Du, C.. “Determinants of Market-Assessed Sovereign Risk: Economic Fundamentals or Market Risk Appetite?” Journal of International Money and Finance, 24 (2005), 533–548.CrossRefGoogle Scholar
Bansal, R.; Khatchatrian, V.; and Yaron, A.. “Interpretable Asset Markets?” European Economic Review, 49 (2005), 531–560.CrossRefGoogle Scholar
Bansal, R.; Kiku, D.; Shaliastovich, I.; and Yaron, A.. “Volatility, the Macroeconomy, and Asset Prices.” Journal of Finance, 69 (2014), 2471–2511.CrossRefGoogle Scholar
Bansal, R.; Kiku, D.; and Yaron, A.. “An Empirical Evaluation of the Long-Run Risks Model for Asset Prices.” Critical Finance Review, 1 (2012), 183–221.CrossRefGoogle Scholar
Bansal, R., and Shaliastovich, I.. “A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets.” Review of Financial Studies, 26 (2013), 1–33.CrossRefGoogle Scholar
Bansal, R., and Yaron, A.. “Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles.” Journal of Finance, 59 (2004), 1481–1509.CrossRefGoogle Scholar
Benzoni, L.; Collin-Dufresne, P.; Goldstein, R. S.; and Helwege, J.. “Modeling Credit Contagion via the Updating of Fragile Beliefs.” Review of Financial Studies, 28 (2015), 1960–2008.CrossRefGoogle Scholar
Berndt, A.; Douglas, R.; Duffie, D.; Ferguson, M.; and Schranz, D.. “Measuring Default Risk Premia from Default Swap Rates and EDFs.” BIS Working Paper No. 173 (2008).Google Scholar
Berndt, A., and Obreja, I.. “Decomposing European CDS Returns.” Review of Finance, 14 (2010), 189–233.CrossRefGoogle Scholar
Bhamra, H. S.; Kuehn, L.-A.; and Strebulaev, I. A.. “The Levered Equity Risk Premium and Credit Spreads: A Unified Framework.” Review of Financial Studies, 23 (2010), 645–703.CrossRefGoogle Scholar
Bollerslev, T. “Generalized Autoregressive Conditional Heteroskedasticity.” Journal of Econometrics, 31 (1986), 307–327.CrossRefGoogle Scholar
Bonomo, M.; Garcia, R.; Meddahi, N.; and Tédongap, R.. “Generalized Disappointment Aversion, Long-Run Volatility Risk, and Asset Prices.” Review of Financial Studies, 24 (2011), 82–122.CrossRefGoogle Scholar
Borri, N., and Verdelhan, A.. “Sovereign Risk Premia.” Working Paper 1343746, SSRN eLibrary (2009).Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.CrossRefGoogle Scholar
Campbell, J. Y., and Taksler, G. B.. “Equity Volatility and Corporate Bond Yields.” Journal of Finance, 58 (2003), 2321–2349.CrossRefGoogle Scholar
Chen, H. “Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure.” Journal of Finance, 65 (2010), 2171–2212.CrossRefGoogle Scholar
Chen, L.; Collin-Dufresne, P.; and Goldstein, R. S.. “On the Relation between the Credit Spread Puzzle and the Equity Premium Puzzle.” Review of Financial Studies, 22 (2009), 3367–3409.CrossRefGoogle Scholar
Doshi, H.; Ericsson, J.; Jacobs, K.; and Turnbull, S. M.. “Pricing Credit Default Swaps with Observable Covariates.” Review of Financial Studies, 26 (2013), 2049–2094.CrossRefGoogle Scholar
Driessen, J. “Is Default Event Risk Priced in Corporate Bonds?” Review of Financial Studies, 18 (2005), 165–195.CrossRefGoogle Scholar
Duffie, D. “Credit Swap Valuation.” Financial Analysts Journal, 55 (1999), 73–87.CrossRefGoogle Scholar
Duffie, D.; Saita, L.; and Wang, K.. “Multi-Period Corporate Default Prediction with Stochastic Covariates.” Journal of Financial Economics, 83 (2007), 635–665.CrossRefGoogle Scholar
Eaton, J., and Gersovitz, M.. “Debt with Potential Repudiation: Theoretical and Empirical Analysis.” Review of Economic Studies, 48 (1981), 289–309.CrossRefGoogle Scholar
Epstein, L. G., and Zin, S. E.. “Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework.” Econometrica, 57 (1989), 937–969.CrossRefGoogle Scholar
Geyer, A.; Kossmeier, S.; and Pichler, S.. “Measuring Systematic Risk in EMU Government Yield Spreads.” Review of Finance, 8 (2004), 171–197.CrossRefGoogle Scholar
Glosten, L. R.; Jagannathan, R.; and Runkle, D. E.. “On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks.” Journal of Finance, 48 (1993), 1779–1801.CrossRefGoogle Scholar
González-Rozada, M., and Yeyati, E. L.. “Global Factors and Emerging Market Spreads.” Economic Journal, 118 (2008), 1917–1936.CrossRefGoogle Scholar
Hamilton, J. D. Time Series Analysis. Princeton, NJ: Princeton University Press (1994).CrossRefGoogle Scholar
Hansen, L. P. “Beliefs, Doubts and Learning: Valuing Macroeconomic Risk.” American Economic Review, 97 (2007), 1–30.CrossRefGoogle Scholar
Hansen, L. P.; Heaton, J. C.; and Li, N.. “Consumption Strikes Back? Measuring Long-Run Risk.” Journal of Political Economy, 116 (2008), 260–302.CrossRefGoogle Scholar
Hansen, L. P., and Sargent, T. J.. “Fragile Beliefs and the Price of Uncertainty.” Quantitative Economics, 1 (2010), 129–162.Google Scholar
Heston, S., and Nandi, S.. “A Closed-Form GARCH Option Valuation Model.” Review of Financial Studies, 13 (2000), 585–625.CrossRefGoogle Scholar
Huang, J.-Z., and Huang, M.. “How Much of the Corporate-Treasury Yield Spread Is Due to Credit Risk?” Review of Asset Pricing Studies, 2 (2012), 153–202.CrossRefGoogle Scholar
Joslin, S.; Le, A.; and Singleton, K. J.. “Why Gaussian Macro-Finance Term Structure Models Are (Nearly) Unconstrained Factor-VARs.” Journal of Financial Economics, 109 (2013), 604–622.CrossRefGoogle Scholar
Kreps, D. M., and Porteus, E. L.. “Temporal Resolution of Uncertainty and Dynamic Choice Theory.” Econometrica, 46 (1978), 185–200.CrossRefGoogle Scholar
Longstaff, F. A.; Pan, J.; Pedersen, L. H.; and Singleton, K. J.. “How Sovereign Is Sovereign Credit Risk?” American Economic Journal: Macroeconomics, 3 (2011), 75–103.Google Scholar
Lustig, H.; Roussanov, N.; and Verdelhan, A.. “Countercyclical Currency Risk Premia.” Journal of Financial Economics, 111 (2014), 527–553.CrossRefGoogle Scholar
Mendoza, E. G., and Yue, V. Z.. “A General Equilibrium Model of Sovereign Default and Business Cycles.” Quarterly Journal of Economics, 127 (2012), 889–946.CrossRefGoogle Scholar
Nelson, D. B. “Conditional Heteroskedasticity in Asset Returns: A New Approach.” Econometrica, 59 (1991), 347–370.CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.CrossRefGoogle Scholar
Pan, J., and Singleton, K. J.. “Default and Recovery Implicit in the Term Structure of Sovereign CDS Spreads.” Journal of Finance, 63 (2008), 2345–2384.CrossRefGoogle Scholar
Reinhart, C. M., and Rogoff, K. S.. “This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises.” Working Paper 13882, National Bureau of Economic Research (2008).CrossRefGoogle Scholar
Remolona, E.; Scatigna, M.; and Wu, E.. “The Dynamic Pricing of Sovereign Risk in Emerging Markets: Fundamentals and Risk Aversion.” Journal of Fixed Income, 17 (2008), 57–71.CrossRefGoogle Scholar
Routledge, B. R., and Zin, S. E.. “Generalized Disappointment Aversion and Asset Prices.” Journal of Finance, 65 (2010), 1303–1332.CrossRefGoogle Scholar
Tédongap, R. “Consumption Volatility and the Cross-Section of Stock Returns.” Review of Finance, 19 (2015), 367–405.CrossRefGoogle Scholar
Timmermann, A. “Moments of Markov Switching Models.” Journal of Econometrics, 96 (2000), 75–111.CrossRefGoogle Scholar
Uribe, M., and Yue, V. Z.. “Country Spreads and Emerging Countries: Who Drives Whom?” Journal of International Economics, 69 (2006), 6–36.CrossRefGoogle Scholar
Wang, H.; Zhou, H.; and Zhou, Y.. “Credit Default Swap Spreads and Variance Risk Premia.” Journal of Banking & Finance, 37 (2013), 3733–3746.CrossRefGoogle Scholar
Weigel, D. D., and Gemmill, G.. “What Drives Credit Risk in Emerging Markets? The Roles of Country Fundamentals and Market Co-Movements.” Journal of International Money and Finance, 25 (2006), 476–502.CrossRefGoogle Scholar
Supplementary material: PDF

Augustin and Tédongap supplementary material

Online Appendix

Download Augustin and Tédongap supplementary material(PDF)
PDF 453.7 KB