Country Credit Risk Research Articles

The Impact of Country Credit Risk Management on the Egyptian Commercial Banks’ Performance - The Moderating Role of Country Liquidity Risk Management

The Impact of Country Credit Risk Management on the Egyptian Commercial Banks’ Performance - The Moderating Role of Country Liquidity Risk Management

Is Macro-Equity Only an Answer to Country Credit Risk, or Can it Promote Sustainable Development?

Is Macro-Equity Only an Answer to Country Credit Risk, or Can it Promote Sustainable Development?

Do sovereign credit ratings matter for corporate credit ratings?

This paper proposes a new approach for tackling the issue of the impact of sovereign rating on corporate ratings. As the policy of never rating a private issuer above its government (sovereign ceiling) has been relaxed by the major credit rating agencies, further empirical investigation is needed to identify the key factors that determine the strength of sovereign-corporate nexus. We suggest implementing a nonlinear panel smooth transition regression modelling where the sovereign effect is allowed to vary across different firm-level financial states. Our results reveal that financially healthier corporations in terms of interest and debt coverage ratios are found to be less dependent on their home country credit risk. Our empirical findings have important implications for credit market participants and offer a call for a better understanding of the role of firm-specific financial characteristics in the rating decisions.

The effect of productivity and country risk on development in the Brazilian Pre-salt Province

ABSTRACTTwelve years after the first significant discovery in the pre-salt layer, pre-salt fields represent about 55% of Brazil’s oil production. Following an economic recession, an increase in the country credit risk, and the 2014 oil price collapse, we analyze the production of petroleum in the pre-salt zones by identifying: the break-even price (BEP), and the effect of oil price, price volatility, productivity, and country risk on wells drilled. To identify these effects on the number of wells drilled into the pre-salt zone, we estimate 100 cointegrating vector autoregression models that specify 10 measures of price and 10 break-even prices. The most accurate model measures oil prices using WTI, has a BEP of $62 per barrel (2018 prices). Results indicate the negative and positive effect, respectively, of raising the country risk and productivity on the number of development wells drilled into the pre-salt zone.

ÜLKE KREDİ RİSK DÜZEYİ, PETROL FİYATLARI VE TEMEL MAKROEKONOMİK GÖSTERGELERİN HİSSE SENEDİ GETİRİLERİNE ETKİSİ: BIST 100 ÖRNEĞİ

ÜLKE KREDİ RİSK DÜZEYİ, PETROL FİYATLARI VE TEMEL MAKROEKONOMİK GÖSTERGELERİN HİSSE SENEDİ GETİRİLERİNE ETKİSİ: BIST 100 ÖRNEĞİ

Currency Strategies and Sovereign Ratings

This paper investigates a link between the most popular currency strategies (carry trade, momentum, value) and sovereign ratings. I document that the profitability of the momentum strategy is large and significant among higher credit risk currencies, but is nonexistent among lower credit risk currencies. The profitability of currency momentum disappears when currencies rated BBB- or worse (16% of currency months) are excluded from the sample. The country credit risk conditions do not apply to the carry trade and value, which are profitable among lower and higher credit risk currencies. Sovereign rating changes do not have a significant impact on the performance of the most popular currency strategies.

Time-varying Co-movements and Contagion Effects in Asian Sovereign CDS Markets

(ProQuest: ... denotes formulae omitted.)I. INTRODUCTIONCredit default swap (CDS) has been one of the fastest growing derivatives in global financial markets for the last decade. A sovereign CDS provides insuranc by securing principal of the bond. For that reason, the sovereign CDS spread1 proxies the risk of the country's financial market as well as its economic situation. From the protection seller's perspective, the CDS spread represents the expected loss from the swap contract. Therefore, a rise in the spread of sovereign CDS indicates a higher probability of expected loss or credit events; the CDS spread can be a useful indicator of a country's credit risk. A number of earlier studies have focused on this aspect. For instance, Hull, Predescu and White (2004) report that changes in the CDS spread are useful in forecasting credit downgrade. Furthermore, it has been argued that CDS markets hold a dominant position over bond markets when it comes to price discovery function: See Blanco et al. (2005), Zhu (2006) and Ammer and Cai (2007).In contrast, the negative aspects of sovereign CDS have been criticized because speculative transactions may generate sudden upward swings in the CDS spread of a particular country. In addition, it has been noted that naked CDS investors-who purchase CDSs only for speculative purposes without possessing the bond-may manipulate the market and cause excessive price increases. The EU has regarded them as one of the factors that provoked the European financial crisis and eventually, at the end of 2012, enforced a regulation to prohibit sovereign CDS trading by naked CDS investors.Considering the economic fundamentals in some emerging economies in East and Southeast Asia, the sovereign CDS spreads in the region fluctuated significantly on the day following the Lehman Brothers bankruptcy: Korea (14.1bp), Philippines (14.7bp), Indonesia (15.2bp) and Malaysia (13.7bp); and on the day following the US credit downgrade: Korea (20.95bp), Philippines (29.99bp), Indonesia (27.09bp) and Malaysia (17.68bp). Dynamic and fast growing Asian emerging economies are susceptible to global variables with a larger volatility. Hence, we cannot rule out the possibility of contagion effects with which a sharp rise in the CDS spread in one nation may be transmitted to other countries, generating higher sovereign default risk in the entire region.Previous literature on the CDS spread mainly analyzes the determinants of the CDS spread. For instance, Duffie (1999), Elton et al. (2001), Huang and Huang (2003) and Longstaffet al. (2005) analyze the relationship between the CDS spread and bonds. Alexander and Kaeck (2008) and Zang et al. (2009) find that the stock market risk is a determinant of the changes in the CDS spread.2 In terms of systemic risk, Lown and Morgan (2006) analyze the impact of credit cycles on the business cycles. However, Gorton and He (2008) argue that credit cycles have their own dynamics separate from business cycles. Despite the plethora of studies on the determinants of the CDS spread-and as a part of such attempts, investigation on the relationship between the CDS spread and other financial markets such as the stock market or foreign exchange market-research on the interconnectedness among sovereign CDS spreads from different countries is rare. The only exception is the work by Gunduz and Kaya (2013), which discovers the co-movement of CDS spreads in ten Eurozone countries by using the Dynamic Conditional Correlation (DCC) model suggested by Engle (2002).The purpose of this paper is to investigate this rarely recognized phenomenonthe interconnectedness of sovereign CDS spreads and the contagion of default risk. To do that, we analyze the co-movements and spillovers in seven Asian sovereign CDS markets after the 2007 global financial crisis. We employ the corrected Dynamic Conditional Correlation (cDCC) model by Aielli (2013), an improved version the DCC model, and identify the correlation among the CDS spreads in our sample countries. …

Banks in International Trade Finance: Evidence from the U.S.

Banks play a critical role in facilitating international trade, in particular by reducing the risk of trade transactions. This paper uses unique information on the trade finance business of U.S. banks to document new empirical patterns. The data reveal that banks' trade finance claims differ substantially across destination countries. They are hump-shaped in country credit risk and increase with the time to import of a destination market. The extent to which trading partners use bank guarantees also varies systematically with global conditions, expanding when aggregate risk is higher and funding is cheaper. The response of bank trade finance to changes in these macro factors is heterogeneous, however. In countries with intermediate levels of credit risk, which rely the most on bank guarantees, bank trade finance adjusts the least. We show that a modification of the standard model of payment contract choice in international trade is needed to rationalize these empirical findings.

Country credit risk determinants with model uncertainty

We analyze the economic and political determinants of country credit risk in both developed and emerging economies by using sovereign yield spreads as risk indicators. We document a high degree of model uncertainty and apply Bayesian Model Averaging to deal with this issue. GDP growth and external debt to GDP ratio are highly likely to influence default risk in emerging and developed economies. Inflation, import growth, openness, and trade freedom are additionally relevant in developed economies, whereas developing countries' default risk is also influenced by debt service ratio, history of recent defaults, and the ratio of foreign exchange reserves to imports.

Political Institutions and Sovereign Borrowing: Evidence from Nineteenth-Century Argentina

I analyze the relationship between political institutions and sovereign borrowing in a simple model where institutions are endogenous and governments vary in their credit risk and political goals. The model formalizes the main intuition in North and Weingast (1989) and also reconciles seemingly contradictory claims in the existing literature. My main result suggests that one has to consider both the direction and the magnitude of the institutional effects on a country's credit risk to establish that greater institutional constraints lead to better borrowing terms. I evaluate the model’s central implications using data on the risk premia of Argentine bonds between 1822 and 1913. My analysis reveals that one cannot reject the existence of a unit root in the series' autoregressive representation. In particular, the existence of a single and distinct break point in 1859 indicates that the adoption of constitutional constraints had a permanent effect on the country's borrowing costs.

Predictability in Emerging Sovereign Debt Markets*

I find strong evidence of economically and statistically significant predictability in Brady bonds, the most liquid emerging debt market, by implementing a new model for credit spreads. Active management provides U.S. investors in emerging markets with double the buy‐and‐hold returns at lower risk and the equivalent of free options on Brady bonds. My analysis suggests that predictability is primarily driven by credit spread deviations from fundamentals rather than time‐varying risk or risk premia. This inefficiency results from the restrictions of a nontransparent, institutionally dominated, dealer market and the lack of a fully developed derivatives market for emerging country credit risk.

The effects of stock market development on growth and private investment in lower-income countries

Recent literature argues that stock market liberalisation has positive long- and short-run effects on macroeconomic growth and private investment, respectively. However, given a sample of up to 64 countries from 1981 through 1998, positive results for long-run growth are largely dependent on the inclusion of higher-income countries in regression samples, which limits the relevance for lower-income nations. Indeed, some evidence in this study indicates that stock market development has a more positive impact on growth for greater levels of per capita GDP, lower levels of country credit risk, and higher levels of legal development. Similarly, using a sample of 26 countries from 1981 through 1998, lagged equity price appreciation seems to boost private investment growth in the short-run, but only in rich countries. All in all, these results imply subdued enthusiasm regarding emerging equity market development.

Predictability in Emerging Sovereign Debt Markets

This paper finds strong evidence of predictability in Brady bonds, the most liquid emerging debt market, by implementing a new model for credit spreads. Predictability is economically and statistically significant and robust to various considerations. Active management provides US investors in emerging markets with double the buy-and-hold returns at lower risk and the equivalent of free options on Brady bonds. Our analysis suggests that predictability is primarily driven by credit spread deviations from fundamentals, rather than time-varying risk or risk premia. We believe this inefficiency is the result of the restrictions of a non-transparent, institutionally dominated, dealer market and the lack of a well developed derivatives market for emerging country credit risk.

Optimal prediction rule: an application to debt reschedulings

This paper develops and tests a new model for assessing country credit risk and is called Multivariate Cumulative Sum. This model is dynamic in nature and allows the user to predict early enough a financial distress that could lead to debt rescheduling. The findings suggest that the model is capable of detecting potential debt - repayment difficulties as early as three years in advance. This has serious financing implications, since the lender can have ample time to re-evaluate his investment opportunities towards that country and thus avoid or limit a disastrous financial exposure.

Expected Returns and Volatility in 135 Countries

We analyze expected returns and volatility in 135 different markets. We argue that country credit risk is a proxy for the ex-ante risk exposure of, particularly, segmented developing countries. We fit a time-series cross-sectional regression using data on the 47 countries which have equity markets. These regressions predict both expected returns and volatility using credit risk as a single explanatory variable. We then use the credit rating data on the other 88 countries to project hurdle rates and volatility into the future. Finally, we calculate for each country, the expected time in years, given the forecasted country risk premium and volatility, for an investor to break even and double the initial investment - with 90% probability. This is the final working paper version of our 1996 Journal of Portfolio Management paper.

Expected Returns and Volatility in 135 Countries

We analyze expected returns and volatility in 135 different markets. We argue that country credit risk is a proxy for the ex-ante risk exposure of, particularly, segmented developing countries. We fit a time-series cross-sectional regression using data on the 47 countries which have equity markets. These regressions predict both expected returns and volatility using credit risk as a single explanatory variable. We then use the credit rating data on the other 88 countries to project hurdle rates and volatility into the future. Finally, we calculate for each country, the expected time in years, given the forecasted country risk premium and volatility, for an investor to break even and double the initial investment - with 90% probability. This is the final working paper version of our 1996 Journal of Portfolio Management paper.