Term premia and credit risk in emerging markets: The role of U.S. monetary policy

Abstract

This paper studies how U.S. monetary policy transmits to the sovereign yields of emerging markets without ignoring credit risk. To quantify the effects, I first identify different types of surprises in U.S. monetary policy using intraday data, and then propose a novel (three-part) decomposition of emerging market yields that accounts for credit risk. I find that surprises in U.S. monetary policy lead to a reassessment of policy rate expectations and a repricing of interest rate and credit risks in emerging markets. Specifically, investors expect monetary authorities in emerging markets to follow the monetary stance of the U.S. central bank rather than counteract it, unconventional U.S. monetary policies transmit to the term premia in emerging markets similarly to the U.S. term premium, and the sovereign credit risk in emerging markets responds to changes in U.S. monetary policy.