A Decomposition of Korean Sovereign Bond Yields: Joint Estimation Using Sovereign CDS and Bond Data

Abstract

We suggest a methodology to decompose sovereign bond yields into four components (riskfree, default risk, risk premium, and non-default) using both sovereign credit default swaps and bond data. Applying the methodology to one of the largest emerging markets, Korea, we find that each fraction varies over time and across bonds. In addition, the default risk accounts for only a small fraction of sovereign yield spreads, and a substantial portion is attributable to risk premium and non-default components. In particular, the risk premium is substantially time-varying; moreover, it increases in order to account for a major portion of the heightened yield spread during a financial crisis, implying that global investors prefer to hold safer assets. Therefore, higher risk premiums per unit risk are required than before. Our findings provide evidence on both flight-to-quality and time-varying risk premium.

Determining Factors for 10-Year Local Currency Sovereign Bonds Yield With Dynamic Regression Model

“…On the contrary, Permanasari & Kurniasih (2021) who also study the same country suggest that the UST yield has no significant effect in determining the LCB yield. Furthermore, findings from Kim & Lee (2014) and Muktiyanto & Aulia (2019) explain that our second predictor, the CDS, is a significant factor that affecting the yield. The first name, using yield spread decomposition approach, suggest that the CDS as a proxy to default risk has 37% contribution to the spread.…”

“…The UST bonds of various maturities are generally used as a benchmark for other countries' sovereign bonds of equivalent maturity (Du et al, 2018). The bonds are considered as the safest instrument hence issuers of other countries usually give extra premium over the UST bonds yield to compensate additional risks taken by investors when purchasing non-UST bonds (Kim & Lee, 2014). Thus, our hypothesis is that the 10-y UST yield influences the Indonesia's LCB yield.…”