In an unprecedented exploration of sovereign credit risk among emerging markets, recent analyses have unveiled intricate dynamics that underpin the fluctuations of Credit Default Swaps (CDS) in the face of global economic shocks, most notably the COVID-19 pandemic. This comprehensive study, expanding upon previous investigations of BRICS and G7 nations, pivots to a carefully curated cohort of twelve emerging economies chosen for their pivotal role in global growth trajectories and financial stability. By isolating countries with complex sovereign credit profiles and excluding those heavily scrutinized or burdened with speculative-grade ratings, the research offers robust insights into the determinants and temporal patterns of sovereign risk as reflected through CDS spreads.
The research period, meticulously defined from January 1, 2018, to December 31, 2021, encapsulates the era bracketing the COVID-19 crisis, allowing for a focused examination of the pandemic’s profound effects on sovereign creditworthiness. Observations disclosed a pronounced surge in CDS values during March and April 2020, a temporal spike emblematic of heightened default probabilities and investor anxiety triggered by the rapid spread of the virus and subsequent economic shutdowns. The temporal concentration of risk peaks coincides with widespread global uncertainty and liquidity shortages, highlighting the susceptibility of emerging economies to exogenous shocks.
Among the twelve emerging market countries under examination—comprising Mexico, Indonesia, Saudi Arabia, Turkey, Poland, Thailand, Malaysia, the Philippines, Egypt, Colombia, Qatar, and Hungary—the sovereign risk profiles exhibited substantial heterogeneity. Turkey and Egypt emerged as focal points with persistently elevated CDS levels, averaging 385.6 and 359.9 basis points respectively, accompanied by significant volatility. These findings underscore the persistence and inertia endemic to countries grappling with intrinsic credit vulnerabilities, whether rooted in fiscal imbalances, geopolitical risks, or structural economic challenges.
The study’s methodological rigor was further reinforced through a series of robustness tests, designed to validate and refine the foundational econometric models. A pivotal adjustment involved shifting the dependent variable from a conventional five-year sovereign CDS to a three-year tenor, thereby honing the model’s sensitivity to near-term credit risk dynamics. This recalibration reflects an acute awareness of the temporal nuances inherent in sovereign risk assessments and aligns analytical focus with market realities that increasingly favor shorter horizons amid rapid economic evolution.
Complementing this temporal refinement, the suite of explanatory variables was expanded to incorporate metrics capturing the impact of short-term sovereign liabilities, including Central Government Short-term Debt and the ratio of Short-term External Debt to Current Account Receipts (CARs). This augmentation acknowledges the critical role that short-term debt structures play in shaping sovereign vulnerability, especially under conditions of market stress where liquidity constraints and rollover risks are amplified. By integrating these variables, the analyses offer a granular perspective on how debt maturity profiles influence sovereign risk perceptions.
Addressing potential endogeneity, the models incorporated a first-order lag for explanatory variables to mitigate reverse causality and rating lag effects, thereby enhancing internal validity. This adjustment ensures that temporal precedence is maintained in the cause-effect relationships estimated, a crucial consideration given the complex feedback loops between economic indicators and sovereign credit spreads. Such methodological sophistication elevates the robustness of the causal inferences drawn.
To attenuate the distorting influence of outliers commonly encountered in financial data, observations were trimmed at the 1st and 99th percentiles, preserving the core sample integrity while reducing skewness induced by anomalous extremes. This statistical measure ensures that the results reflect typical sovereign risk dynamics without being unduly influenced by rare but extreme events, thereby strengthening the generalizability of findings.
Empirical results from the robustness tests reaffirmed key economic interpretations regarding sovereign credit risk. Variables indicative of economic prosperity, such as GDP per capita and real GDP growth, consistently demonstrated positive and statistically significant relationships with the core dependent variable, designated here as ({{COR}}_{{it}}). The coefficients ranged robustly, underscoring the beneficial role of economic development in mitigating sovereign risk. These results correspond with theoretical expectations that stronger economic fundamentals reduce the probability of default and reassure market participants.
Conversely, inflation manifested a significant negative association with ({{COR}}_{{it}}), implying that higher inflation rates correlate with a reduction in the measured risk variable. This counterintuitive finding invites a nuanced interpretation, potentially reflecting inflation’s complex effects on nominal debt burdens and government revenues in emerging economies, or methodological artifacts arising from the model’s specification.
Trade balance relative to GDP also exhibited a positive relationship with sovereign credit risk, implying that trade surpluses might elevate perceived risk, possibly due to external dependency or commodity price volatility prevalent in emerging markets. In juxtaposition, higher usable reserves relative to GDP displayed a negative effect on credit risk metrics, consistent with the notion that ample reserves function as a buffer against external shocks and market turmoil.
The integration of central government short-term debt and short-term external debt to current account revenues into the explanatory framework highlighted the adverse influence of short-term maturities on sovereign credit risk. Notably, the presence of these variables rendered previously significant fiscal indicators, such as the government gross balance to GDP ratio, statistically insignificant, signaling the paramount importance of liquidity and rollover risks over traditional fiscal positions in capturing sovereign vulnerability.
Risk premium measures and government effectiveness emerged as central determinants with strongly positive and statistically supported impacts on sovereign risk spread estimates. The coefficients for risk premium ranged between 0.079 and 0.098, while those for government effectiveness spanned from 0.476 to 0.532, all at high levels of statistical significance. These findings align with broader economic literature underscoring the roles of market perceptions and institutional quality in sovereign debt markets, where governance efficiency can mitigate risks and elevate investor confidence.
Regulatory quality, while generally positive in its association with ({{COR}}_{{it}}), exhibited some variability in significance, suggesting that its influence may be context-dependent or intertwined with other institutional factors. Default history exerted a notably strong negative effect on sovereign risk measures, with coefficients between −8.016 and −6.033, reinforcing the criticality of historical credit events in shaping present-day market assessments.
Strengthened by high explanatory power—with R-squared values ranging from 0.84 to 0.92—the empirical models effectively captured the determinants of sovereign credit spreads within the emerging market milieu. These results speak to the comprehensive nature of the econometric framework and the careful selection of variables that collectively account for a substantial share of the variation in sovereign risk measures.
The alignment of robustness test outcomes with baseline regressions adds a layer of confidence to the study’s conclusions. This consistency affirms that the identified relationships are not artifacts of specific model configurations or sample peculiarities but reflect enduring economic realities governing sovereign credit risk. Such stability reinforces the trust that policymakers, investors, and analysts can place in these metrics and their interpretations.
Ultimately, this body of research illuminates the dualistic forces at play in emerging market sovereign risk: the buoyant effects of economic vigor and institutional strength juxtaposed against the suppressive impacts of inflation and adverse credit legacies. Recognizing these dynamics empowers decision-makers with a refined analytical lens to anticipate shifts in sovereign risk premia, calibrate risk management strategies, and formulate policies aimed at bolstering resilience.
In light of the COVID-19 induced shock waves, the detailed temporal mapping of credit risk via CDS time series from 2018 to 2021 offers a vivid chronicle of crisis transmission and recovery phases within emerging economies. The March-April 2020 peak epitomizes a crisis moment whose ripples continue to inform sovereign risk assessments well beyond the immediate shock.
The incorporation of short-term debt structures and liquidity considerations into sovereign risk modeling presents a critical advancement, reflecting the nuanced challenges faced by emerging markets in managing rollover risks amid volatile capital flows. This approach invites further exploration of debt management strategies and their interface with market perceptions.
In the broader context, these findings contribute to a refined understanding of sovereign risk in a world increasingly defined by rapid global shocks, institutional evolution, and the interconnectedness of financial systems. They underscore the imperative for emerging economies to balance short-term liquidity needs with long-term fiscal sustainability while fostering strong governance frameworks to sustain market access and investor trust.
As the global community navigates the aftermath of the pandemic and anticipates future economic disruptions, insights garnered from this research offer a valuable compass. They empower stakeholders with empirical evidence to guide sovereign debt management, risk pricing, and policy formulation, thereby enhancing the prospects of sustainable economic development in emerging market contexts.
Subject of Research: Dynamic linkages and determinants of sovereign CDS and exchange rates in emerging markets with a focus on robustness tests and the impact of COVID-19.
Article Title: Dynamic linkages and determinants of sovereign CDS and exchange rates: evidence from G7 and BRICS.
Article References:
Su, M., Ren, Y., Niu, Y. et al. Dynamic linkages and determinants of sovereign CDS and exchange rates: evidence from G7 and BRICS.
Humanit Soc Sci Commun 12, 659 (2025). https://doi.org/10.1057/s41599-025-04985-8
Image Credits: AI Generated
