Bond Spreads Research Articles

Is to Forgive to Forget? Sovereign Risk in the Aftermath of a Default

We examine the link between sovereign defaults and credit risk, by taking into account the depth of a debt restructuring and by distinguishing between commercial and official debt. The focus is on debt restructuring events, which take place at the end of a default spell. We use a novel methodology (Jorda and Taylor 2016) to estimate the average treatment effect of a default episode on our outcome variables, agency ratings and bond yield spreads, accounting for the endogeneity of the default. Our results show that the average treatment effect on ratings is negative (and positive for bond spreads) up to seven years following a default, while the opposite holds for a default with official creditors. Our results are robust to using a panel analysis, which allows us to investigate on the importance of the (final) haircut size. Specifically, we and that the rating (spread) variation (increase) is larger for cases with deeper haircuts. Therefore, we and evidence that official and private defaults may have different costs and then induce selective defaults.

The South African–United States sovereign bond spread and its association with macroeconomic fundamentals

AbstractThe yield spread of South African to United States 10‐year government bonds over the last 5 years has increased substantially to levels approaching those last seen during the mid‐1980s. This paper examines the association between the spread and macroeconomic fundamentals over the 1960–2019 sample period, under the GARCH and GARCH‐M class of estimators. We find that higher South African economic growth, lower inflation, public and private debt, as well as rand–dollar appreciation are all associated with a statistically significantly lower South African–United States yield spread. The strongest impact is associated with the public debt‐to‐GDP ratio. Mean spread levels do not appear to be influenced by yield volatility. Finally, while there is no evidence of sign bias in the impact of shocks on yield volatility (negative shock impacts are no different than positive), there is evidence of size bias for both positive and negative shocks: larger shocks have a larger impact on volatility than small, regardless of their sign. Collectively, and even ignoring the impact of private sector leveraging, South Africa’s performance in these macroeconomic fundamentals is associated with an increase in the South African–United States yield spread of 363 basis points (since 2012).

Liquidity and price pressure in the corporate bond market: evidence from mega-bonds

Larger bonds offer greater liquidity, which should reduce their yields. A simple way for firms to reduce financing costs is to sell bonds with large face values. We find that mega-bonds are more liquid than smaller bonds. However, offering yield spreads on mega-bonds are not lower and are higher than spreads of bonds issued by similar companies. The discount applied to large new issues is consistent with price pressure effects that are also present in the secondary market prices of the issuing firm's existing bonds. Our results suggest a hidden cost to issuing very liquid bonds.

Research on the Impact of Third-Party Certification on Green Bond Spread of the Green Industry－Considering the Effect of the Nature of Property Rights

Capital is the most basic element of production organization, and green bonds are important financing sources for the green industry. Financingcosts directly affect the steady development of the green industry. In order to verify whether third-party certification can reduce the financing cost of green bonds and whether the nature of property rights has an impact on the reduction, 285 green bonds issued from 2016 to 2019 are taken as samples, and then a hierarchical multiple statistical regression analysis method is adopted to conduct a quantitative study. The results show that third-party certification, as a unique credit enhancement method for green bonds, can significantly reduce green bond spreads. In addition, it isgreater that the effect on non-state-owned enterprises’ green bonds is. Since bond spread isamain part of financing costs, the above means that third-party certification can reduce the financing costs of green bonds, especiallyfor non-state-owned enterprises. In this regard, starting from reducing the cost of green bonds, the paper proposes to improve the green bond evaluation and certification standards as soon as possible, non-state-owned enterprises particularly should actively carry out third-party certification, and the government needs to further increase the implementation of third-party certification as well as strengthen multi-party cooperation.

Dealer Inventory Constraints in the Corporate Bond Market during the COVID Crisis

<ns2:p>Beginning in late February 2020, market liquidity for corporate bonds dried up and corporate bond credit spreads soared amid broad financial market dislocations related to the COVID-19 pandemic. The causes of this liquidity dry-up and the spike in corporate bond spreads remain subjects of debate.</ns2:p>

COVID-induced sovereign risk in the euro area: When did the ECB stop the spread?

This paper studies how the announcement of the ECB’s monetary policies stopped the spread of the COVID-19 pandemic to the European sovereign debt market. We show that up to March 9, the occurrence of new cases in euro area countries had a sizeable and persistent effect on 10-year sovereign bond spreads relative to Germany: 10 new confirmed cases per million people were accompanied by an immediate spread increase of 0.03 percentage points (ppt) that lasted 5 days, for a total increase of 0.35 ppt. For periods afterwards, the effect falls to near zero and is not significant. We interpret this change as an indicator of the success of the ECB’s March 12 press conference, despite the “we are not here to close spreads” controversy. Our results hold for the stock market, providing further evidence of the effectiveness of the ECB’s March 12 announcements in stopping the financial turmoil. A counterfactual analysis shows that without the shift in the sensitivity of sovereign bond markets to COVID-19, spreads would have surged to 4.2% in France, 12.5% in Spain, and 19.5% in Italy by March 18, when the ECB’s Pandemic Emergency Purchase Programme was finally announced.

Role of global, regional, and advanced market economic policy uncertainty on bond spreads in emerging markets

This paper investigates the predictive content of news-based advanced market, regional, and global economic policy uncertainty (EPU) measures for bond spreads and their volatility in emerging markets (EMs) by extending the higher (k-th) order nonparametric causality-in-quantiles test to a multivariate case. Results show that global and advanced market EPU measures have predictive power for EM bond spreads in the lower and upper quantiles while for volatility, the predictive power is stronger in the upper quantiles and further observes predictability in the mid quantiles. Predictability detected for all EMs is characterized by an inherent heterogeneity leading to an asymmetric pattern over the distribution of EM bond spreads and volatility. The implication for heterogeneity in our results is that when EPU is high in advanced markets, global investors’ appetite for the EM local currency bonds increases due to high yields. However, when EPU is low, global investors move out of EMs because of the perceived unsafe investment environments in EMs.

Euro, dollar or Swiss franc: which currency had the greatest impact on the Hungarian, Polish and Czech economies during the global financial crisis?

The article presents an analysis of the impact of foreign currency dynamics on the fundamentals (basic indices of the economic performance) of the Czech Republic, Hungary and Poland during the financial crisis of 2007/2008 and its aftermath until 2017. The subject of the analysis are three currencies: the US dollar, the euro and the Swiss franc. The assessment of their impact on the fundamentals of the three above-mentioned economies is based on the joint volatilities of bond spreads and currencies. A series of copula-GARCH models was estimated. The research demonstrates that the impact of foreign currencies was the strongest in the case of Poland and Hungary, as these two countries were more dependent on loans in foreign currencies than the Czech Republic. Another finding shows that the impact decreased significantly in Hungary after its government introduced loan conversion.

Risk modeling of macroeconomic shocks and their effects on foreign debt of Russian companies

The article examines the possible consequences of the new “Great Lockdown” crisis and their impact on the stability of the corporate sector in terms of external obligations. The author examines the trends in the dynamics of external debt and formulates the main threats to macroeconomic stability (sanctions, world recession, low oil prices), describes the scenario of shock propagation and its impact on companies’ solvency. Based on a sample for the period from 2006Q1 to 2020Q1 (57 observations) using the least squares method, three theoretical regression models (for the entire period, shock and “quiet” quarters) were constructed to explain the change in the level of debt burden of the corporate sector from a number of macroeconomic variables: capital outflow, foreign assets, oil prices, LIBOR rates, credit bond spread, etc. The results obtained can be used in the implementation of debt and prudential policies.

Markov-Switching Models with State-Dependent Time-Varying Transition Probabilities

Markov-switching models with covariate-dependent transition functions that are subject to exogenous discrete stochastic changes are considered. These changes are associated with simultaneous stochastic changes in the covariance structure of the observable variables. Simulation experiments are carried out to assess the quality of large-sample approximations to the distributions of the maximum-likelihood estimator and of related statistics in such a model, and to examine the implications of misspecification due to unaccounted breaks in the transition mechanism. The practical use of the model is illustrated by analyzing the relationship between Argentinian sovereign bond spreads and output growth.

Fact or fiction: Implicit government guarantees in China’s corporate bond market

This paper explores how implicit government guarantees affect the yield spreads of Chinese corporate bonds. We argue that quasi-municipal corporate bonds (“Chengtou” bonds), issued by local government financing vehicles (LGFVs), carry an implicit government guarantee and therefore enjoy a reduced yield spread. Using a sample of publicly traded corporate bonds between 2010 and 2017, we show that bond investors are significantly less sensitive to bond-specific risks for corporate bonds with an implicit government guarantee: the yield spreads of Chengtou bonds are significantly lower than those of corporate bonds issued by privately-owned enterprises (POEs). Furthermore, we find that policy changes introduced by China’s central government, which were intended to regulate local governments’ debt financing activities, significantly reduced the gap in yield spreads between Chengtou bonds and bonds issued by POEs. Overall, our results suggest that implicit government guarantees play a crucial role in China’s nascent corporate bond market, but that the country’s recent policy changes have reduced the effectiveness of such guarantees, making China’s corporate bond market more market-oriented.

Covid-19 and high-yield emerging market bonds: insights for liquidity risk management

Around the apogee of the pandemic crisis in late March 2020, trading liquidity has evaporated out of high-yield (HY) bond markets across developing states. Concerned about this phenomenon, we assess emerging market (EM) debt liquidity as a combination of three metrics: (i) bid–ask spreads; (ii) relative liquidity score incorporating market depth, trading volumes, and time needed to liquidate an asset; and (iii) round-trip transaction costs—evidencing that all have worsened by the end of the first quarter of 2020. We complement our analysis by tracking the dynamics of the option-adjusted spreads of the EM HY bonds and document that the recovery trends of the credit and liquidity components in bonds spreads have decoupled in the aftermath of the Covid-triggered global meltdown. We evidence relevant differences in bond liquidity between chosen countries, representative of geopolitical regions. All the considered liquidity measures provide a coherent picture of the pandemic impact and allow for insights regarding the recovery from the crisis turmoil and the risk management of the EM HY bond portfolios throughout a systemic crisis.

Common Factors in the Term Structure of Credit Spreads and Predicting the Macroeconomy in Japan

This study extracts the common factors from firm-based credit spreads of major Japanese corporate bonds and examines the predictive content of the credit spread on the real economy. Instead of employing single-maturity corporate bond spreads, we focus on the entire term structure of the credit spread to predict the business cycle. We extend the dynamic Nelson-Siegel model to allow for both common and firm-specific factors. The results show that the estimated common factors are important drivers of individual credit spreads and have substantial predictive power for future Japanese economic activity. This study contributes to the literature by examining the relationship between firm-based credit spread curves and economic fluctuation and forecasting the business cycle.

Term spreads and the COVID-19 pandemic: Evidence from international sovereign bond markets

We explore the impact of the COVID-19 pandemic on the term structure of interest rates. Using data from developed and emerging countries, we demonstrate that the expansion of the disease significantly affects sovereign bond markets. The growth of confirmed cases significantly widens the term spreads of government bonds. The effect is independent of government policy and monetary responses to COVID-19 and robust to many considerations.

The effect of bank relationships on bond spreads: Additional evidence from Japan

This study investigates the impact of bank relationships on bond spreads using data on Japanese bond-issuing firms. In doing so, it extends the existing literature, which found that bank relationships decrease bond spreads, consistent with the view that bond investors benefit from bank monitoring, but this is not the case for investment-grade bonds in the US. This study provides evidence that the influence on the yields of investment-grade bonds varies with the type of bank relationship. In this research, a main bank is defined as a bank that is not merely the top lender to a firm but also one of the ten largest shareholders, while firms that borrow money from banks but have no ties with main banks are considered to have support bank relationships. The regression results show that although main bank relationships are not systematically associated with the yields of investment-grade bonds, support bank relationships are positively associated with them. It is suggested that, even for a sample of investment-grade bonds, a specific type of bank relationship affects bond spreads and the association between them is consistent with the view that bond investors are concerned about the hold-up problem posed by banks.

Sukuk and bond spreads

Sukuk are considered as an alternative instrument in Islamic finance. However, the structures and provisions make sukuk dissimilar to bonds. Literature is having difficulty in the comparison between the performance/integration of the sukuk and bonds issued at the same time. To fill the existing literature gap on sukuk risk, we focus on the yield spread by comparing the sukuk yield to bond yield through their main determinants by using the data of financial and non-financial firms at weekly level. We use 123 firms that issued both sukuk and bond at the same period for years between 2013 and 2018. We employ sukuk and bonds data that are issued by same company and issued at the same period and market. Accordingly, we are able to minimize factors that raised from sukuk and bonds structure differences. Using the panel generalized least squares estimations, we find that global factors, such as US government yield bonds make significant impact on the sukuk-bond differences. In particular, the negative returns create more significant differences. However, on the other hand, the global shocks in sukuk markets, proxied by DJ sukuk index, are highly limited. By using the quantile analysis, we find that the effects of higher or lower bond spreads do not change.

The Influence of US Dollar Funding Conditions on Asian Financial Markets

More than 20 years after the Asian financial crisis, the region’s continued high reliance on United States (US) dollar-denominated funding has significant implications for the transmission of global financial conditions to domestic financial and macroeconomic circumstances. Given limited domestic capital market-based financing solutions, a high reliance on funding denominated in US dollars renders countries vulnerable to changing global financial and liquidity conditions. Using a dynamic panel and a vector autoregression model to assess the exchange rate as a possible transmission channel, we find that changes in bilateral US dollar exchange rates can have a significant impact on sovereign credit risk. In particular, a depreciation of the domestic currency against the US dollar leads to a widening of the sovereign bond spread. This finding suggests a significant relationship between US dollar funding exposure, US dollar liquidity conditions, and domestic financial conditions in some emerging Asian economies, and thus highlights one source of structural vulnerability. Given that the magnitude of the effects varies across countries, policy makers need to monitor closely the interplay between the exchange rates and local financial market conditions with tailored prescriptions for domestic financial resilience.

Uncertainty Premia, Sovereign Default Risk, and State-Contingent Debt

We analyze how concerns for model misspecification on the part of international lenders affect the desirability of issuing state-contingent debt instruments in a stan- dard sovereign default model a la Eaton and Gersovitz (1981). We show that for the commonly used threshold state-contingent bond structure (e.g., the GDP-linked bond issued by Argentina in 2005), the model with robustness generates ambiguity premia in bond spreads that can explain most of what the literature has labeled as novelty premium. While the government would be better off with this bond when facing rational expectations lenders, this additional source of premia leads to welfare losses when facing robust lenders. Finally, we characterize the optimal design of the state-contingent bond and show how it varies with the level of robustness. Our find- ings rationalize the little use of these instruments in practice and shed light on their optimal design.

A regression discontinuity design for ordinal running variables: Evaluating central bank purchases of corporate bonds

Regression discontinuity (RD) is a widely used quasi-experimental design for causal inference. In the standard RD the assignment to treatment is determined by a continuous pretreatment variable (i.e., running variable) falling above or below a prefixed threshold. Recent applications increasingly feature ordered categorical or ordinal running variables which pose challenges to RD estimation due to the lack of a meaningful measure of distance. This paper proposes an RD approach for ordinal running variables under the local randomization framework. The proposal first estimates an ordered probit model for the ordinal running variable. The estimated probability of being assigned to treatment is then adopted as a latent continuous running variable and used to identify a covariate-balanced subsample around the threshold. Assuming local unconfoundedness of the treatment in the subsample, an estimate of the effect of the program is obtained by employing a weighted estimator of the average treatment effect. Two weighting estimators—overlap weights and ATT weights—as well as their augmented versions are considered. We apply the method to evaluate the causal effects of the corporate sector purchase programme (CSPP) of the European Central Bank which involves large-scale purchases of securities issued by corporations in the euro area. We find a statistically significant and negative effect of the CSPP on corporate bond spreads at issuance.

Redenomination risk in eurozone corporate bond spreads

We investigate the risk spillover from euro area government bond spreads (relative to a safe German government bond of similar maturity) to nonfinancial corporate bonds in France, the Netherlands (‘hard’ euro-area countries), and Italy, Portugal and Spain (‘soft’ euro-area countries). In addition to standard firm- and bond-specific determinants of corporate bonds (capturing liquidity and tax effects, and other euro area macroeconomic risks), we show that there is significant risk transfer from government bonds to the nonfinancial corporate sector. After decomposing the government bond spread into a default risk and a currency redenomination risk component, associated with a possible split in the euro, we find that redenomination risk has been a significant factor in the pricing of corporate bonds, particularly in the ‘soft’ euro-area countries.