The relationship of international bond spreads and sovereign credit ratings. A cross-section analysis
An essential component of interest payments on public debt is the sovereign risk component, which compensates bond investors for taking the risk of the sovereign issuer not fulfilling its foreign-currency obligations. The study of this sovereign risk and the related international bond-spread component is important to understanding the nature and causes of interest-rate movements and bond-market developments. The authors model the relationship between sovereign credit ratings - an explicit proxy of sovereign risk - and the market's risk assessment, encompassed by international bond spreads. Based on the model, they consider whether the risk spread paid by the Hungarian sovereign issuer is consistent with the Hungarian credit rating, i. e. whether the evaluations of Hungarian sovereign risk by market participants and by rating agencies are consistent with each other. The study also examines, with two cross-section samples in global sovereign bond markets, how the relationship of ratings and spreads changed in 2005 and what factors the differences can be attributed to.
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