Working Paper Series
Why Does Sovereign Risk Differ for Domestic and Foreign Investors? Evidence from Scandinavia, 1938–1948
Abstract: Recent theoretical models suggest that the costs
governments face when defaulting on their domestic and external debt may
differ considerably. This paper examines if this proposed cost difference
is reflected in sovereign risk spreads across domestic and foreign markets.
Specifically, I analyze market yields on Danish government debt in both
Denmark and Sweden during 1938–1948, i.e., a period full of political
shocks as well as a wartime segmentation of Scandinavian capital markets.
By linking the exogenous wartime shocks to changes in the costs of
defaulting on domestic and external sovereign debt, it is found that these
costs explain a significant part of the variation in the sovereign risk
spread across markets. The result is robust to a multitude of tests and the
inclusion of additional yield spread influences such as differences in
macroeconomic fluctuations, portfolio allocation opportunities, local risk
aversion and microstructure institutions.
Keywords: Sovereign Risk; Investor Heterogeneity; Domestic Debt; External Debt; Market Segmentation; Political Economy; Cliometrics; (follow links to similar papers)
JEL-Codes: F34; G15; G18; N20; N24; N44; (follow links to similar papers)
24 pages, November 23, 2006
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