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Sovereign Default Risk and the U.S. Equity Market

Published online by Cambridge University Press:  06 February 2017

Alexandre Jeanneret
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Abstract

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This paper develops a two-country asset pricing model with defaultable firms and governments. This model shows that higher sovereign credit risk in a country depresses equity prices internationally and increases their volatility. The effect is strongest during adverse economic conditions and when firms are close to financial distress. A structural estimation provides evidence that sovereign default risk in Europe affects European and U.S. stock markets through the threat of an economic slowdown.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 1 , February 2017 , pp. 305 - 339
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Footnotes

1 I am very grateful for comments and suggestions from an anonymous referee, Daniel Andrei, Philippe Bacchetta, Kenza Benhima, Hendrik Bessembinder (the editor), Harjoat Bhamra, Michael Brennan, Julien Cujean, Georges Dionne, Christian Dorion, Darrell Duffie, Bernard Dumas, Ruediger Fahlenbrach, Thierry Foucault, Mathieu Fournier, Pascal François, Jeffrey A. Frankel, Laurent Frésard, Geneviève Gauthier, Rajna Gibson, Gunnar Grass, Michael Hasler, Ricardo Hausmann, Christopher Hennessy, Julien Hugonnier, Jean Imbs, Robert Merton, Erwan Morellec, Boris Nikolov, Anna Pavlova (discussant), Aude Pommeret, Norman Schuerhoff, Eduardo Schwartz, Philip Valta, Wei Yang (discussant), and participants at the 2010 Bank of Canada Conference in Ottawa, 2010 CREDIT Conference in Venice, 2011 Mathematical Finance Days in Montréal (conference paper award), 2012 Western Finance Association (WFA), Copenhagen Business School, EDHEC Business School, HEC Montréal, Norwegian School of Management, Rice University, University of Amsterdam, University of Houston, University of Lausanne, and Vienna Graduate School of Finance (GSF) for helpful comments. I acknowledge the financial support from Swiss Finance Institute and the National Centre of Competence in Research (NCCR) Financial Valuation and Risk Management (FINRISK), managed by the Swiss National Science Foundation, HEC Montréal, Institut de Finance Mathématique de Montréal (IFM2), and the Fonds Québécois de la Recherche sur la Société et la Culture (FQRSC). All errors are mine.

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