The Determinants of Israel’s Cost of Capital: Globalization, Reforms and Politics

We examine fluctuations in the risk premium on Israeli sovereign debt traded in the US between 1996 and 1999. We find that, during this period, Israelís risk premium was predominantly affected by global events, most notably the crises in Asia and Russia. Domestic and regional events (e.g. the peace process, political changes, terrorist attacks, and economic reforms) had a miniscule immediate impact on the risk premium. By contrast, in the year 2000, Israeli bond prices were more affected by Israel specific events, perhaps as a result of dramatic events in that year, or due to the absence of major global emerging market crises. We also examine abnormal stock returns of Israeli companies traded in the US and find that, in contrast with Israelís sovereign debt, some domestic political events appear to have had an impact on their cost of capital even prior to 2000. Much like Israelís sovereign bonds, Israeli stock prices were far more sensitive to domestic events in 2000 than they had been in earlier years.