Simon Gilchrist, Bin Wei, Vivian Z. Yue, and Egon Zakrajšek
Working Paper 2021-27
November 2021

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Abstract: In this paper, we study the interplay between sovereign risk and global financial risk. We show that a substantial portion of the comovement among sovereign spreads is accounted for by changes in global financial risk. We construct bond-level sovereign spreads for dollar-denominated bonds issued by more than 50 countries from 1995 to 2020 and use various indicators to measure global financial risk. Through panel regressions and local projection analysis, we find that an increase in global financial risk causes a large and persistent widening of sovereign bond spreads. These effects are strongest when measuring global risk using the excess bond premium, which is a measure of the risk-bearing capacity of US financial intermediaries. The spillover effects of global financial risk are more pronounced for speculative-grade sovereign bonds.

JEL classification: E43, E44, F33, G12

Key words: sovereign bonds, CDS, global financial risk, excess bond premium, global financial cycle

The authors thank Yan Bai (discussant), Roberto Chang, Hélène Rey, Jesse Schreger (discussant), Eric Van Wincoop, Martin Uribe, and participants in the 2021 National Bureau of Economic Research's International Seminar on Macroeconomics conference and seminars at Rutgers University, the Federal Reserve Banks of Atlanta and San Francisco, and the National Bank of Belgium. They also thank Giulio Cornelli and Chelsea Hunter for excellent research assistance. The views expressed here are those of the authors and not necessarily those of the Banks for International Settlements or the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to Simon Gilchrist, Department of Economics, New York University and the National Bureau of Economic Research; Bin Wei, Research Department, Federal Reserve Bank of Atlanta; Vivian Z. Yue, Department of Economics, Emory University and Research Department, Federal Reserve Bank of Atlanta and the National Bureau of Economic Research and the Centre for Economic Policy Research; or Egon Zakrajšek, Monetary and Economic Department, Bank of International Settlements and the Centre for Economic Policy Research.

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