Financial system

Yield (engineering)

Metallurgy

Materials science

Interest rate

Portfolio

Economics

Risk premium

Covered interest arbitrage

Liberian dollar

Interest rate parity

Business

Bond market

Exchange rate

Monetary economics

Local currency

Foreign exchange risk

Financial economics

Bond

Finance

Credit risk

Currency

Journal of money credit and banking

In emerging market economies, currency appreciation goes hand in hand with 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 U.S. dollar exchange rate, not the trade‐weighted exchange rate. Our findings highlight endogenous co‐movement of bond risk premia and exchange rates through the portfolio choice of global investors who evaluate returns in dollar terms.

Bond Risk Premia and The Exchange Rate