The Term Structure of Sovereign Default Risk in an Emerging Economy

We study the time-varying structure of sovereign default risk in Colombia focusing on different time spans indicated by yield spreads of government bonds with different maturities. Instrumental-variable regressions are performed to analyze whether the drivers of this risk change along its term structure. We show that although spreads are correlated across maturities, their relative behavior and determinants are not uniform. In fact, we are able to identify some determinants that drive sovereign risk at long-run maturities but are not related to short-run risk, namely, government indebtedness, terms of trade and international reserves. Short-run risk is mostly driven by investment, asset prices and international trade indicators. In contrast to recent literature, we find that domestic factors are more important drivers of sovereign risk than global factors in Colombia. In addition, global factors are found to be relatively more important as drivers of long-run risk versus short-run risk.

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