| Abstract |
This paper studies local currency (LC) sovereign credit risk in emerging markets.
The LC sovereign risk spread is constructed as the difference between the LC government bond yield spread and the LC currency risk spread, which is inferred from the
exchange rate forward market. Using data from 2005 to 2020, I find that, unlike foreign currency (FC) sovereign risk, LC sovereign risk is insulated from global factors
such as global risk aversion (VIX) and US interest rates. Moreover, the discrepancy
between FC and LC sovereign risk, and the isolation of LC sovereign risk, is not altered by higher foreign participation in the domestic market. An event study of the
inclusion of LC government bonds into global indices suggests that foreign inflows
into the domestic government bond market suppress LC bond yield and currency risk
spreads, but LC credit risk remains invariant. |