Macroeconomic Fundamentals and the Shape of Sovereign Credit Risk

Daniele Bianchi and Teng Jiao

♦ Sovereign CDS spreads price the credit risk embedded in government borrowing. We ask how macroeconomic fundamentals predict that risk, and whether a linear mapping from fundamentals to spreads is adequate. Across a large panel of OECD economies, linear methods perform well across countries but lose predictive accuracy after 2022 and fail to capture how spreads vary across maturities. Non-linear methods recover both. While linear forecasts mainly rely on fiscal ratios, non-linear predictions draw on the term-structure slope throughout, inflation during the 2022–2024 monetary tightening, and consumer confidence during the Eurozone crisis. These predictive relationships hold panel-wide rather than country-by-country.

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