Sovereign yields and the risk-taking channel of currency appreciation

Revised version, May 2017

BIS Working Papers  |  No 538  | 
18 January 2016

Currency appreciation goes hand in hand with easier financial conditions and compressed sovereign bond spreads, even for local currency sovereign bonds. This yield compression comes from a reduction in the credit risk premium. Crucially, the relevant exchange rate involved in yield compression is the bilateral dollar exchange rate, not the trade-weighted exchange rate. Our findings point to a financial risk-taking channel of currency appreciation associated with the global role of the dollar.

JEL classification: G12, G15, G23

Keywords: bond spread, capital flow, credit risk, emerging market, exchange rate