Macroeconomic Fundamentals and the Shape of Sovereign Credit Risk

Abstract

We examine whether macroeconomic fundamentals have lost relevance in explaining sovereign credit risk. Analyzing CDS premiums across developed and emerging economies through the lenses of flexible ensemble regression trees, we find that real-time macroeconomic indicators maintain significant predictive power. An interpretable decomposition of the forecasts reveals key economic underpinnings, such as the non-linear sensitivity of expected CDS premiums to labor market conditions, debt-to-GDP, interest rates, and yield curve slopes. Linear models fail to capture the full extent of these relationships, contributing to an apparent disconnect between fundamentals and CDS premiums, especially during periods of economic distress.

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Citation

Bianchi, Daniele, and Teng Jiao. “Macroeconomic Fundamentals and the Shape of Sovereign Credit Risk.” Working paper.

@article{bianchi2024macroeconomic,
  title={Macroeconomic Fundamentals and the Shape of Sovereign Credit Risk},
  author={Bianchi, Daniele and Jiao, Teng},
  journal={Available at SSRN 4976334},
  year={2024}
}