DP16750 Sovereign Risk and Financial Risk

Author(s): Simon Gilchrist, Bin Wei, Vivian Yue, Egon Zakrajsek
Publication Date: December 2021
Date Revised: December 2021
Keyword(s): CDS, Excess Bond Premium, Global financial cycle, Global financial risk, Sovereign bonds
JEL(s): E43, E44, F34, G12
Programme Areas: Financial Economics, International Macroeconomics and Finance, Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16750

In this paper, we study the interplay between sovereign risk and global financial risk. We show that a substantial portion of the comovement among sovereign spreads is accounted for by changes in global financial risk. We construct bond-level sovereign spreads for dollar-denominated bonds issued by over 50 countries from 1995 to 2020 and use various indicators to measure global financial risk. Through panel regressions and local projection analysis, we find that an increase in global financial risk causes a large and persistent widening of sovereign bond spreads. These effect are strongest when measuring global risk using the excess bond premium -- a measure of the risk-bearing capacity of U.S. financial intermediaries. The spillover effects of global financial risk are more pronounced for speculative-grade sovereign bonds.