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CEP discussion paper
US Real Interest Rates and Default Risk in Emerging Economies
Nathan Foley-Fisher and Bernardo Guimaraes
October 2009
Paper No' CEPDP0952:
Full Paper (pdf)

JEL Classification: F34; G15

Tags: real interest rates; default; sovereign debt; identification through heteroskedasticity

We empirically analyse the appropriateness of indexing emerging market sovereign debt to US real interest rates. We find that policy-induced exogenous increases in US rates raise default risk in emerging market economies, as hypothesised in the theoretical literature. However, we also find evidence that omitted variables which simultaneously increase US real interest rates and reduce the risk of default dominate the hypothesised relationship. We can only conclude that it’s not a good idea to index emerging market bonds to US real interest rates.