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Emerging markets sovereign CDS spreads during COVID-19: Economics versus epidemiology news

Timo B. Daehler, Joshua Aizenman () and Yothin Jinjarak

Economic Modelling, 2021, vol. 100, issue C

Abstract: Can bad news about COVID-19 induce negative expectations on sovereign credit risks? We investigate the factors driving credit default swap (CDS) spreads of emerging market sovereigns around the outbreak of COVID-19. Using 2014–2019 data, we estimate a two-factor model of global and regional risks and then extrapolate the model-implied spreads for the period July 2019–June 2020. Intriguingly, the model initially predicts the realized spreads well but loses predictive accuracy during the COVID-19 pandemic. Fiscal space and oil-revenue dependence primarily drive the differences between the realized and predicted sovereign spreads. Our augmented-factor model indicates that the cumulative COVID-19 mortality rate growth is positively associated with the CDS spreads. The evidence suggests that the epidemiological deterioration can lower confidence in the sovereign credit markets due to the prospects of prolonged lockdowns and a slower GDP growth recovery. Our results also hold for a single regression of daily spread changes during 2014–2020.

Keywords: Emerging markets; Sovereign spreads; Fiscal space; Oil shocks (search for similar items in EconPapers)
JEL-codes: F30 F34 F41 H12 H50 H51 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:100:y:2021:i:c:s0264999321000936

DOI: 10.1016/j.econmod.2021.105504

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