Comovement or safe haven? The effect of corruption on the market risk of sovereign bonds of emerging economies during financial crises

In this study, I explore the role of corruption in the cross-market time-varying linkage between sovereign bonds of emerging markets and the US stock market. I show that corruption plays a prominent role in the behaviour of comovement under various market conditions. Sovereign bonds' sensitivity to systematic shocks increases during financial crises when those bonds are issued by countries perceived to be more corrupt. The returns on bonds issued by less corrupt countries are determined more idiosyncratically under extreme market conditions and realize more hedging benefits against S&P 500 risk. To explain these findings, I propose a comovement model built on Barberis et al. (2005). When sentiment deteriorates, ambiguity-averse investors load more worldwide news on sovereign bonds issued by more corrupt countries where information uncertainty is perceived to be higher.