Publications
Publications
  • June 2016
  • Article
  • Journal of Finance

Local Currency Sovereign Risk

By: Wenxin Du and Jesse Schreger
  • Format:Print
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Abstract

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.

Keywords

Risk and Uncertainty; Sovereign Finance; Currency; Emerging Markets

Citation

Du, Wenxin, and Jesse Schreger. "Local Currency Sovereign Risk." Journal of Finance 71, no. 3 (June 2016): 1027–1070.

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