Essays in Sovereign Credit Risk

This dissertation investigates aspects of sovereign credit risk in advanced and emerging economies. It consists of two chapters. Chapter 1 studies the determinants of sovereign credit default swap (CDS) spreads for 16 advanced economies during the recent financial crisis. We document that the state of the world financial system, and since the beginning of the crisis, the state of a country’s domestic financial system, have strong explanatory power for the behavior of CDS spreads. Furthermore, the magnitude of this effect depends on the relative importance of a country's financial system pre-crisis. Our results suggest the presence of a private-to-public risk transfer through which market participants incorporate their expectations about the potential burden of government intervention. Chapter 2 studies the extent to which macro-economic variables govern the dynamics of emerging market sovereign CDS spreads. In this chapter, I propose a structural model of sovereign credit risk based on a country's access to international capital flows through exports, imports and international reserves. The joint dynamics of the sovereign’s repayment capacity and the amount of outstanding debt determine the level of default risk and thus the sovereign CDS spread. I implement the model for a sample of six emerging economies for a period covering the recent financial crisis. A calibrated version of the model captures the widening of sovereign spreads during the crisis and provides a good fit for their time-series dynamics. Lastly, I find that the market-implied level of country liabilities is on average 13% larger than the reported level of debt.