This paper examines the nature of sovereign credit risk using an extensive sample of CDS spreads for 26 developed and emerging-market countries. Sovereign credit spreads are surprisingly highly correlated, with just three principal components accounting for more than 50 percent of their variation. Sovereign credit spreads are generally more related to the U.S. stock and high-yield bond markets, global risk premia, and capital flows than they are to their own local economic measures. The study finds that the excess returns from investing in sovereign credit are largely compensation for bearing global risk, and that there is little or no country-specific credit risk premium. A significant amount of the variation in sovereign credit returns can be forecast using U.S. equity, volatility, and bond market risk premia. The data for this study consists of monthly sovereign credit default swap (CDS) premia for each of the countries in the sample. CDS contracts function as insurance contracts that allow investors to buy protection against the event that a sovereign defaults on or restructures its debt. The pricing data for five-year sovereign credit default swaps used in this study are obtained from the Bloomberg system. The sample covers the period from October 2000 to May 2007. The results indicate that sovereign credit spreads are driven primarily by external factors; the country-specific component of sovereign credit risk is relatively modest. Common financial market factors and time-varying risk premia induce significant correlation between sovereign credit spreads. Thus, the portfolios of lenders and investors in the sovereign debt markets may be less diversified than is generally believed. Furthermore, the absence of a unique sovereign credit risk premium in sovereign credit returns raises questions about viewing this market as a separate asset class; a diversified portfolio of U.S. stock and bond positions reproduces a substantial portion of the historic excess returns in the sovereign debt market.This paper examines the nature of sovereign credit risk using an extensive sample of CDS spreads for 26 developed and emerging-market countries. Sovereign credit spreads are surprisingly highly correlated, with just three principal components accounting for more than 50 percent of their variation. Sovereign credit spreads are generally more related to the U.S. stock and high-yield bond markets, global risk premia, and capital flows than they are to their own local economic measures. The study finds that the excess returns from investing in sovereign credit are largely compensation for bearing global risk, and that there is little or no country-specific credit risk premium. A significant amount of the variation in sovereign credit returns can be forecast using U.S. equity, volatility, and bond market risk premia. The data for this study consists of monthly sovereign credit default swap (CDS) premia for each of the countries in the sample. CDS contracts function as insurance contracts that allow investors to buy protection against the event that a sovereign defaults on or restructures its debt. The pricing data for five-year sovereign credit default swaps used in this study are obtained from the Bloomberg system. The sample covers the period from October 2000 to May 2007. The results indicate that sovereign credit spreads are driven primarily by external factors; the country-specific component of sovereign credit risk is relatively modest. Common financial market factors and time-varying risk premia induce significant correlation between sovereign credit spreads. Thus, the portfolios of lenders and investors in the sovereign debt markets may be less diversified than is generally believed. Furthermore, the absence of a unique sovereign credit risk premium in sovereign credit returns raises questions about viewing this market as a separate asset class; a diversified portfolio of U.S. stock and bond positions reproduces a substantial portion of the historic excess returns in the sovereign debt market.