Emerging Markets Sovereign Spreads and Country-Specific Fundamentals During COVID-19
This case study compares the importance of prevailing market factors against COVID-19 dynamics and policy responses in explaining the daily evolution of emerging market (EM) sovereign CDS spreads during the first half of 2020. We adopt a two-stage econometric approach. In the first stage, we estimate a multi-factor model for changes in EM CDS spreads over the pre-COVID-19 period of January 2014 through June 2019. Among the factors are a regional and a global one with the former capturing the CDS dynamic of a country’s regional EM peers and the latter capturing the CDS dynamic of advanced economies (the US, Eurozone, and Japan). Next, we extrapolate model-implied changes in CDS spreads from July 2019 to June 2020. The model traces the realized sovereign spreads well over the rest of 2019, breaks down in 2020, and sees the biggest deviations from model-implied values during peak COVID in March. In the second stage, we find that the March 2020 divergence is partly accounted for by traditional determinants such as fiscal space, oil shocks, and monetary policies by the FED and the ECB rather than by COVID-specific risks and associated policies. In particular, COVID cases, mortalities, and virus containment policies were no significant drivers of CDS spread adjustments over this period. Overall, the study points to two results: On the one hand, the residuals during COVID suggest a time-varying relationship between sovereign CDS spreads and explanatory variables. On the other hand, the residuals were not driven by COVID-specific risks but rather by traditional drivers of sovereign debt pricing.
We gratefully acknowledge the financial support by the Dockson Chair and the Center of International Studies at USC. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.