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The Journal of Fixed Income

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Primary Article

The Dynamic Pricing of Sovereign Risk in Emerging Markets

Fundamentals and Risk Aversion

Eli M Remolona, Michela Scatigna and Eliza Wu
The Journal of Fixed Income Spring 2008, 17 (4) 57-71; DOI: https://doi.org/10.3905/jfi.2008.705542
Eli M Remolona
Head of economics for Asia and the Pacific at the Bank for International Settlements in Hong Kong, SAR.
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  • For correspondence: eli.remolona@bis.org
Michela Scatigna
A resarch assistant at the Bank for International Settlements in Basel, Switzerland.
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  • For correspondence: michela.scatigna@bis.org
Eliza Wu
A senior lecturer at the School of Banking and Finance, University of New South Wales in Sydney, Australia.
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  • For correspondence: e.wu@unsw.edu.au
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Abstract

This article introduces a new approach to pricing sovereign risk based on sovereign credit default swap (CDS) spreads. We estimate a dynamic market-based measure of sovereign risk and use it to decompose sovereign CDS spreads into expected losses from default and the market risk premia required by investors as compensation for default risk. Using a dynamic panel data model, we find that country-specific fundamentals primarily drive sovereign risk while global investors' risk aversion drives time variation in the risk premia. Consistent with this, we also find that the sovereign risk premia is more highly correlated than sovereign risk itself within emerging market regions. These results help us to explain the remarkable narrowing of emerging market spreads between 2002 and 2006 and to understand the pricing mechanism and channel of contagion for emerging debt markets.

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The Journal of Fixed Income
Vol. 17, Issue 4
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The Dynamic Pricing of Sovereign Risk in Emerging Markets
Eli M Remolona, Michela Scatigna, Eliza Wu
The Journal of Fixed Income Mar 2008, 17 (4) 57-71; DOI: 10.3905/jfi.2008.705542

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The Dynamic Pricing of Sovereign Risk in Emerging Markets
Eli M Remolona, Michela Scatigna, Eliza Wu
The Journal of Fixed Income Mar 2008, 17 (4) 57-71; DOI: 10.3905/jfi.2008.705542
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