Geopolitical risk and emerging market sovereign risk premia
Summary
Focus
We examine how geopolitical risks affect sovereign risk premia for emerging market economies (EMEs). We focus on two measures of sovereign risk: five-year sovereign credit default swap (SCDS) spreads, which show the cost of insuring against a country's default, and JPMorgan Emerging Markets Bond Index (EMBI) spreads, which reflect the extra return investors demand for holding emerging market bonds.
Contribution
We make three key contributions:
- We study how geopolitical risks affect both SCDS and EMBI spreads, giving a clear view of sovereign risk in EMEs.
- We separate the effects of geopolitical threats (anticipated risks) from acts (realised events), showing how these affect sovereign risk differently.
- We use a method to show how macro-financial conditions shape the impact of geopolitical risks. We also compare responses before and after the start of the Russia–Ukraine conflict.
Findings
We identify three main findings:
- Geopolitical risks raise sovereign risk premia: a rise in geopolitical risk increases both SCDS and EMBI spreads. SCDS spreads respond more strongly because they are more liquid and used for hedging.
- Threats matter more than acts: anticipated risks, such as warnings of conflict, have a bigger and longer-lasting impact on sovereign risk premia than realised events. This shows that bond markets react to risks early.
- Macro-financial conditions amplify the effects: geopolitical risks have a stronger impact during heightened financial stress, worsening commodity terms of trade for net-importing EMEs, and increased sovereign-risk co-movement. For example, after the Russia–Ukraine conflict began, geopolitical risks had a stronger effect on both SCDS and EMBI spreads.
These findings highlight the need for governments and investors to monitor geopolitical risks and macro-financial conditions together. Doing so would help them to better manage borrowing costs and sovereign risk.
Abstract
This study examines how geopolitical risk (GPR) transmits to sovereign credit risk in emerging market economies (EMEs), using monthly data on the 5-year sovereign credit default swap (SCDS) and the J.P. Morgan Emerging Markets Bond Index (EMBI) spread for 13 EMEs over the period of January 2005–October 2025. Using fixed-effects panel local projections, the framework is extended to allow for state-dependent transmission. Differences in impulse responses across states are attributed to specific macrofinancial fundamentals. Three main findings are identified. First, an increase in the GPR index raises both SCDS and EMBI spreads. Second, disaggregating the index into its subcomponents reveals a larger response to threats than to acts, consistent with the possibility of anticipation effects in sovereign credit markets. Third, evaluating the state-dependent impulse response around the Russian invasion of Ukraine yields substantially different responses, with the post-invasion configuration increasing the sovereign risk premia response. Our findings show the importance of modeling the state-dependent transmission of geopolitical shocks and provide a useful tool for incorporating geopolitical scenarios into sovereign risk analysis.
JEL Codes: C23, C54, F34, G15
Keywords: sovereign risk, credit default swaps, EMBI, emerging markets, geopolitical risk, panel local projections, state-dependent transmission
