Abstract
We provide new empirical evidence that unspanned global macroeconomic risk bears some responsibility for the strong co-movement in sovereign spreads. To rationalize these findings, we embed a reduced-form default process into an equilibrium model with downside risk for CDS spreads. Countries differ through their sensitivity to global macroeconomic forecasts and uncertainty. Exploiting the high-frequency information in the CDS term structure across 38 countries, we estimate the model and find parameters consistent with preference for early resolution of uncertainty. Our results confirm the existence of time-varying risk premia in sovereign spreads as a compensation for exposure to common U.S. business cycle risk.