Real Economic Shocks and Sovereign Credit Risk
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.
Authors: Patrick Augustin, Roméo Tédongap
Citations: 123
Published: 2016-04-01T00:00:00.000Z
Why It Matters
Venue: Journal of Financial and Quantitative Analysis. Year: 2016. Citations: 123. Abstract signal: 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 wit...
Abstract
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.
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