Local Currency Sovereign Risk

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 si...

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Bibliographic Details
Published in:The Journal of finance (New York) 2016-06, Vol.71 (3), p.1027-1070
Main Authors: DU, WENXIN, SCHREGER, JESSE
Format: Article
Language:English
Subjects:
Capital
Credit default swaps
Credit risk
Cross border transactions
Currencies
Currency
Debt
Emerging markets
Financial market
Investors
Loan defaults
Risk factors
Sovereign debt
Spread
Studies
Treasury bonds
Yield curves
Zero coupon bonds
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Summary: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.
ISSN:0022-1082
1540-6261
DOI:10.1111/jofi.12389