Euro-denominated Bonds Research Articles

Currency crisis: Turkey in 2021

Research methodology This case study is developed from secondary sources. Two types of data were used to develop this case. The statistical data are gathered from sources such as Yahoo! Finance, Trading Economics, Investing.com and The Central Bank of the Republic of Turkey. Reports on market developments are gathered from major news outlets such as Bloomberg, The Wall Street Journal and Reuters. Case overview/synopsis The year 2021 was a volatile year for the Turkish economy: it ended the year with 36% annual inflation, 44% currency devaluation, shortages of basic goods, street protests, etc. How does the Turkish currency crisis in 2021 play out in various financial markets such as the foreign exchange, bond, stock and cryptocurrency markets? This case study introduces students to Turkey’s economic crisis in 2021 and how the Turkish lira’s depreciation, home inflation and central bank policies interact to affect its various financial markets. In the bond market, a depreciated lira heightened the credit risk of Turkey’s bond issuers and effectively crippled the country’s bond market. In contrast, Turkey’s stock and cryptocurrency markets experienced a rally as Turks put their money into equities and cryptocurrencies to hedge against inflation. In international trade, the lira’s fall and the supply chain disruptions in Asia benefited Turkish exporters tremendously. In contrast, Turkish importers suffered. In the Turkish society, the impact of the currency and inflation crisis fell the hardest on ordinary folks, who saw the values of their wages and pension benefits erode. In times of hardship, socially responsible citizens helped the poor by anonymously paying for others’ unpaid bills. Complexity academic level Given the multicomplexity of a currency crisis, this case would be valuable for finance/economics students to understand how a country’s currency crisis and its central bank policies interact to impact its various financial markets. This case is appropriate for courses in Markets and Institutions with a global or cultural learning objective. Learning Objectives 1. Describe how the Turkish lira’s depreciation affected its various financial markets, such as foreign exchange, bond, stock and cryptocurrency markets.2. Understand the cultural perspective on usury, how it exists in modern-day finance, and its’ role in President Recep Tayyip Erdoğan’s economic policy.3. Compare and contrast Turkey’s export and import industries and how they are being affected by the lira’s depreciation.4. Evaluate the risk exposure of foreign investors who participate in Turkey’s stock market given a depreciating lira.5. Evaluate the creditworthiness of Turkish corporations who issued dollar- or euro-denominated bonds as well as issuers of lira-denominated bonds given a depreciating lira.6. Understand the social impacts of a currency crisis and the charitable acts of socially responsible citizens.

The green bonds: Empirical evidence and implications for sustainability

This paper explores the pricing of green bonds in the Italian primary and secondary market and their implications for sustainability by investigating the effect that a green label has on a bond's spread through propensity score matching. From a sample of 420 fixed-rate, euro-denominated bonds priced at on the euro mid-swap from 2014 to the first half of 2021, bonds with a green label are matched with conventional bonds, to assess whether there is a significant difference in spreads between them. The results on the primary market show that green bonds' issuance spread is, on average, 35 to 40 basis points lower than that of comparable conventional bonds at a highly significance level.The spread discount seems to persist regardless of the issuer's sector, even with a difference in the magnitude, being remarkably higher for corporates. On the secondary market, the estimation results confirm the discount impact of the green label on the bonds' market spread, even if this impact is lower than at the issuance. This study aims at giving better coverage of the advantages green bonds are able to generate also in a relatively small and illiquid financial markets. Furthermore, we show that green bonds are effective instruments for issuers to achieve a lower cost of debt to finance green projects and for investors to support the transition to a greener and more sustainable economy.

Fickle Emerging Market Flows, Stable Euros, and the Dollar Risk Factor

Policymakers fear the potentially destabilizing impact of fickle global investors on emerging markets. Euro area investors are significant participants in emerging bond markets and exhibit volatile flows, but their fickleness does not result in indiscriminate periods of surge and flight. Instead, we find differentiation across emerging market bonds based on currency denomination and issuer-level risk factors. First, euro area investors exhibit a strong home currency bias that manifests itself both as a cross-sectional preference and in the form of relatively stable flows to Euro-denominated bonds over time. Second, volatile flows to USD and local-currency denominated bonds are most robustly related to fluctuations in the broad dollar exchange rate. Attempts to explain the dollar factor yield modest evidence for a balance sheet mechanism, and, consistent with a broader risk appetite channel, we find flows to bonds with lower credit ratings and higher yield spreads are more sensitive to USD fluctuations.

Global and Local Currency Effects on Euro Area Investment in Emerging Market Bonds

We analyze how global and local factors affect portfolio allocation by euro area investors in emerging markets at the bond-level. First, cross-sectional analysis reveals a strong preference for home (Euro) currency bonds. Second, panel regressions, whether at the bond or aggregate flows level, consistently identify trade-weighted US dollar fluctuations as the most robust explanatory variable, in sharp contrast to other global factors, such as the VIX and Fed or ECB monetary policy, which have much less impact on reallocations to emerging market bonds. Our results are consistent with the notion that broad US dollar movements act as a barometer for global risk appetite, but with an important caveat: Throughout our analysis we find holdings in Euro-denominated bonds are less sensitive to global factors, which we interpret as further evidence of a home currency bias.

The Time-Varying Impact of Systematic Risk Factors on Corporate Bond Spreads

During the global financial crisis, stressed market conditions led to skyrocketing corporate bond spreads that could not be explained by conventional modeling approaches. This paper builds on this observation and sheds light on time-variations in the relationship between systematic risk factors and corporate bond spreads. First, we apply Bayesian model averaging to a battery of candidate variables for determining meaningful systematic risk factors. Second, Markov switching techniques provide us with an endogenous separation of regimes accounting for times of stress, on the one hand, and for normal market conditions, on the other. Our evidence for market indices of euro-denominated bonds suggests that systematic risk factors play a much more prominent role during periods of market turmoil. Most important, expectations about default rates seem to be much more driven by systematic factors rather than idiosyncratic components during times of market stress.

A two-stage estimator for heterogeneous panel models with common factors

The estimation in a stationary heterogeneous panel model where unknown common factors are present is considered. A two-stage estimator is proposed and compared to existing alternative methods for the estimation of slope parameters in panels with a multifactor error structure. The asymptotic properties of this estimator are provided alongside the comparison of its finite-sample properties with those of a range of estimators by means of Monte Carlo experiments. The two-stage estimator affords a greater computational simplicity with respect to existing iterative estimators that fail to achieve convergence in a relevant number of cases considered. The proposed estimator is employed in the analysis of the determinants of Euro-denominated bonds in a framework of a heterogeneous panel data model with multifactor error structure.

The conditional performance of Euro bond funds: evidence from Portugal during the debt crisis

ABSTRACTThis paper evaluates the performance of a survivorship bias-free data set of Portuguese funds investing in Euro-denominated bonds by using conditional models that consider the public information available to investors when the returns are generated. We find that bond funds underperform the market significantly and by an economically relevant magnitude. This underperformance cannot be explained by the expenses they charge. Our findings support the use of conditional performance evaluation models, since we find strong evidence of both time-varying risk and performance, dependent on the slope of the term structure and the inverse relative wealth variables. We also show that survivorship bias has a significant impact on performance estimates. Furthermore, during the European debt crisis, bond fund managers performed significantly better than in non-crisis periods and were able to achieve neutral performance. This improved performance throughout the crisis seems to be related to changes in funds’ investment styles.

The Conditional Performance of Euro Bond Funds: Evidence from Portugal During the Debt Crisis

This paper evaluates the performance of a survivorship bias-free dataset of Portuguese funds investing in Euro-denominated bonds by using conditional models that consider the public information available to investors when the returns are generated. We find that bond funds underperform the market significantly and by an economically relevant magnitude. This underperformance cannot be explained by the expenses they charge. Our findings support the use of conditional performance evaluation models, since we find strong evidence of both time-varying risk and performance, dependent on the slope of the term structure and the inverse relative wealth variables. We also show that survivorship bias has a significant impact on performance estimates. Furthermore, during the European debt crisis, bond fund managers performed significantly better than in non-crisis periods and were able to achieve neutral performance. This improved performance throughout the crisis seems to be related to changes in funds’ investment styles.

Sovereign Bond Purchases and Risk Sharing Arrangements: Sharing: Myth and Reality of the European QE

In March, the Eurosystem started to purchase on the secondary market euro-denominated bonds issued by governments, agencies and European institutions. The total amount of bond purchases is estimated to 1.14 trillion EUR until September 2016, or 60 billion EUR per month. The size of the Expanded Asset Purchase Program raises issues of scarcity of bonds to be purchased by the Eurosystem without inducing a fall of yields at record (negative) levels. Several sovereign bonds (Germany, France, Netherlands) already exhibit negative rates. Against this background, this paper reviews the main features of government bond markets in the Euro-area, including its size, structure, and current developments. Moreover it discusses the (potential) financial risks that the Eurosystem might be taking on its balance sheet in view of the currently low (or negative) yields and (expected) shortage in supply of sovereign bonds.

Currency Wars

Currency Wars

A Factor Analysis Approach to Measuring European Loan and Bond Market Integration

By using an existing and a new convergence measure, this paper assesses whether bank loan and bond interest rates are converging for the corporate sector across the euro area. Our sample of 828 bond issues suggests that integration of the primary euro-denominated bond market is complete; there is evidence of α -convergence, β -convergence, strong factor convergence, and absence of σ -convergence. In contrast, the market for bank loans remains segmented albeit at various degrees depending on the type and size of the loan. Factor analysis reveals that rates on large loans and long-term small loans have weakly converged in the sense that, up to a fixed effect, their evolution is driven by common factors only. In contrast, the evolution of short-term small loan rates is still affected by country-specific dynamic factors. These working capital type of loans are more susceptible to information problems and, therefore, possibly to distortions in loan pricing. There are few signs that bank loan rates are becoming more uniform with time.

Who Drove the Boom in Euro-Denominated Bond Issues?

We make use of micro-level data for over 45,000 private bond issues by over 5000 firms from 22 countries in 1990-2006 to analyze the impact that the launch of the EMU had on their currency denomination. The use of the micro data allows us to isolate the effect on new and seasoned bond issuers while conditioning on individual issue characteristics. To our knowledge, ours is the first systematic analysis of this topic the micro level. We find that the impact on new issuers is larger than on seasoned issuers and that most of the increase in the euro-denominated bond issuance by seasoned borrowers was along the extensive margin, i.e. borrowers switching currency denomination of their issues. Insofar as new entrants to the bond market will define the overall currency composition in the long run, these results imply that aggregate studies might be underestimating the euro effect. We also find that to a large extent the increase in euro issuance was at the expense of U.S. dollar issuance, suggesting that euro competes with the U.S. dollar as a currency of choice for international - financial transactions.

Who Drove the Boom in Euro-Denominated Bond Issues?

We make use of micro-level data for over 45,000 private bond issues by over 5000 firms from 22 countries in 1990-2006 to analyze the impact that the launch of the EMU had on their currency denomination. The use of the micro data allows us to isolate the "euro effect" on new and seasoned bond issuers while conditioning on individual issue characteristics. To our knowledge, ours is the first systematic analysis of this topic at the micro level. We find that the impact on new issuers is larger than on seasoned issuers and that most of the increase in the euro-denominated bond issuance by seasoned borrowers was along the "extensive" margin, i.e. borrowers switching currency denomination of their issues. Insofar as new entrants to the bond market will define the overall currency composition in the long run, these results imply that aggregate studies might be underestimating the euro effect. We also find that to a large extent the increase in euro issuance was "at the expense" of U.S. dollar issuance, suggesting that euro competes with the U.S. dollar as a currency of choice for international financial transactions.

Who Drove the Boom in Euro-Denominated Bond Issues?

We make use of micro-level data for over 45,000 private bonds issued by over 5000 firms from 22 countries in 1990-2006 to analyze the impact that the launch of the EMU had on the currency denomination of the bond issues. To our knowledge, ours is the first systematic analysis of issue the micro level. The use of the micro data allows us to distinguish between the response to the advent of the euro by new and seasoned bond issuers, and to condition on other issue characteristics. We find that the impact on new issuers is larger than on seasoned issuers and that most of the increase in the euro-denominated bond issuance was along the extensive margin. Insofar as new entrants to the bond market will define the overall currency composition in the long run, these results imply that aggregate studies might be underestimating the euro effect. We also find that to a large extent the increase in euro issuance was at the expense of U.S. dollar issuance, suggesting that the euro competes with the U.S. dollar as a currency of choice for international financial transactions.

Does Government Ownership Affect the Cost of Debt? Evidence from Privatization

We explore whether retained government ownership affects the cost of debt for fully and partially privatized companies during 2001-2005 using 811 observations of bond-specific and firm-specific panel data. On average, a one percentage point decrease in government ownership is associated with an increase in the credit spread, used as a proxy for the cost of debt, by one-half of a basis point, suggesting the importance of implicit government guarantees. However, post-privatization firm improvements allow fully privatized companies to enjoy lower credit spreads than partially privatized firms. These results indicate the cost of a lengthy privatization process where ownership uncertainty and bondholder-shareholder conflicts force debt pricing upwards. The presence of a golden share serves to delineate the state’s role in partially privatized firms, resulting in a lower cost of debt. In fully privatized companies, however, this remnant of government control is associated with higher spreads. Credit ratings, firm profitability, and euro-denominated bonds exhibit consistent negative associations with the rate at which companies can borrow funds from the capital markets. A treatment effects model accounting for characteristics that drive governments’ ownership retention corroborates our results. Among other factors governments seem more likely to retain stakes when the unemployment rate is higher and when the national GDP is growing.

Estimating the Term Structure of Credit Spreads on Euro-denominated Corporate Bonds

In this paper, we estimate the term structure of credit spreads on Euro-denominated corporate bonds with a modified version of the Duffee (1999) intensity-based model. The empirical analysis considers monthly observations for a sample of investment-grade euro-denominated corporate bonds analysed for rating classes. The model is estimated with a maximum likelihood – Kalman filter approach over different sample periods ranging from January 1999 to August 2006. The estimation results, in general, support the application of the theoretical model to the euro-denominated bond market and exhibit some interesting characteristics of this relatively recent market.

Issue costs in the Eurobond market: The effects of market integration

This study compares the issuance costs of Eurobonds before and after the completion of the Economic and Monetary Union (EMU) in 2002. We find that the introduction of the Euro has significantly reduced the issue cost of Euro-denominated bonds compared to bonds denominated in the legacy currencies. The reduction in issue cost is not due to a decrease in underwriter compensation, but rather to the elimination of underpricing (the difference between the market price after trading commences and the offering price). Underwriter fee has declined substantially after the completion of the EMU, but this decline has been offset by an increase in underwriter spread (the difference between the offering price and the guaranteed price to the issuer), leaving total underwriter compensation unchanged. The EMU is also associated with significant reductions in bond maturity and syndicate size, consistent with its expected effects on liquidity and issue costs in the Eurobond market.

The International Role of the Euro: Evidence from Bonds Issued by Non-Euro Area Residents

This paper analyses the main features of the market for euro-denominated bonds issued by non-euro area residents on the basis of a new database. It shows that large private corporations from mature economies have contributed significantly to the internationalisation of the euro since 1999, more than sovereigns in transition and emerging economies, whose part was initially expected to be stronger. It confirms that the euro’s international role is characterised by a strong regional focus, being most prominent in countries located in the immediate vicinity of the euro area. In particular, the paper provides ample evidence that the City of London plays a key role in the market for euro-denominated bonds issued by non-euro area residents, be it on the supply side, the demand side or as an intermediary. When it comes to demand, the paper shows that the euro’s reach in the rest of the world has been more limited thus far, notwithstanding some recent interest in Asia. Finally, the paper finds evidence that the international role of the euro has, to some extent, been driven by the euro area itself, with euro area investors being significant purchasers of euro-denominated bonds issued by non-euro area residents.