Sovereign bond risk premiums

Engelbert Dockner, Manuel Mayer and Josef Zechner

No 2013/28, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: Credit risk has become an important factor driving government bond returns. We therefore introduce an asset pricing model which exploits information contained in both forward interest rates and forward CDS spreads. Our empirical analysis covers euro-zone countries with German government bonds as credit risk-free assets. We construct a market factor from the first three principal components of the German forward curve as well as a common and a country-specific credit factor from the principal components of the forward CDS curves. We find that predictability of risk premiums of sovereign euro-zone bonds improves substantially if the market factor is augmented by a common and an orthogonal country-specific credit factor. While the common credit factor is significant for most countries in the sample, the country-specific factor is significant mainly for peripheral euro-zone countries. Finally, we find that during the current crisis period, market and credit risk premiums of government bonds are negative over long subintervals, a finding that we attribute to the presence of financial repression in euro-zone countries.

Keywords: Sovereign bond risk premiums; Market and credit risk factors; Financial repression (search for similar items in EconPapers)
Date: 2013
New Economics Papers: this item is included in nep-eec, nep-fmk and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Sovereign Bond Risk Premiums (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfswop:201328

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