Sovereign default risk,debt uncertainty and fiscal credibility: The case of Brazil

Since Credit Default Swaps spreads reflect the sovereign risk and, thus, the uncertainties related to government solvency, the goal of this study is to examine the relation between sovereign risk and debt uncertainty (measured by the disagreement in expectations about public debt) in an important developing country – Brazil. Furthermore, the paper analyzes whether fiscal credibility plays a key role in mitigating the effect of debt uncertainty on sovereign risk. The results suggest the disagreement in expectations about public debt affects the sovereign risk, and fiscal credibility plays a twofold role, it reduces sovereign risk, and it mitigates the effect of debt uncertainty on sovereign risk. Besides, quantile regression estimates reveal that fiscal credibility improvements are even more important when sovereign risk levels are higher.     

RECENT DEVELOPMENTS IN QUANTITATIVE MODELS OF SOVEREIGN DEFAULT

The current crisis and discussions, in the euro area in particular, show that sovereign debt crises/defaults are no longer confined to developing economies. Following crises in many Latin American countries, the literature on quantitative dynamic macro models of sovereign default has been advancing rapidly. Current debate should take note of the findings of this literature – an extensive overview of which has been provided in this paper. This paper also discusses the inherent difficulties as well as possibilities of integrating this type of model into standard business cycle models (RBC and DSGE models). This is likely to be particularly helpful when using models to analyse upcoming issues in the euro area, such as a suitable sovereign insolvency law or the assumption of joint liability.     

Modeling Financial Sector Joint Tail Risk in the Euro Area

We develop a novel high‐dimensional non‐Gaussian modeling framework to infer measures of conditional and joint default risk for numerous financial sector firms. The model is based on a dynamic generalized hyperbolic skewed‐t block equicorrelation copula with time‐varying volatility and dependence parameters that naturally accommodates asymmetries and heavy tails, as well as nonlinear and time‐varying default dependence. We apply a conditional law of large numbers in this setting to define joint and conditional risk measures that can be evaluated quickly and reliably. We apply the modeling framework to assess the joint risk from multiple defaults in the euro area during the 2008–2012 financial and sovereign debt crisis. We document unprecedented tail risks between 2011 and 2012, as well as their steep decline following subsequent policy actions. Copyright © 2016 John Wiley & Sons, Ltd.     

Global Credit Risk: World,Country and Industry Factors

We investigate the dynamic properties of systematic default risk conditions for firms in different countries, industries and rating groups. We use a high‐dimensional nonlinear non‐Gaussian state‐space model to estimate common components in corporate defaults in a 41 country samples between 1980:Q1 and s2014:Q4, covering both the global financial crisis and euro area sovereign debt crisis. We find that macro and default‐specific world factors are a primary source of default clustering across countries. Defaults cluster more than what shared exposures to macro factors imply, indicating that other factors also play a significant role. For all firms, deviations of systematic default risk from macro fundamentals are correlated with net tightening bank lending standards, suggesting that bank credit supply and systematic default risk are inversely related. Copyright © 2016 John Wiley & Sons, Ltd.     

Assessment of time-varying systemic risk in credit default swap indices: Simultaneity and contagiousness

This study assesses systemic risk inherent in credit default swap (CDS) indices using empirical and statistical analyses. We define systemic risk in two perspectives: the possibilities of simultaneous and contagious defaults, and then quantify them separately across benchmark models. To do so, we employ a Marshall-Olkin copula model to measure simultaneous default risk, and an interacting intensity-based model to capture contagious default risk. For an empirical test, we collect daily data for the iTraxx Europe CDS index and its tranche prices in the period from 2005 to 2014, and calibrate model parameters varying across time. In addition, we select forecasting models that have minimal prediction errors for the calibrated time series. Finally, we identify significant changes in each dynamic of systemic risk indicator before and after default and downgrade-related episodes that have occurred in the global financial crisis and European sovereign debt crisis.     

An update on EMU sovereign yield spread drivers in times of crisis: A panel data analysis

We empirically investigate the determinants of EMU sovereign bond yield spreads with respect to the German bund. Using panel data techniques, we examine the role of a wide set of potential drivers. To our knowledge, this paper presents one of the most exhaustive compilations of the variables used in the literature to study the behaviour of sovereign yield spreads and, in particular, to gauge the effect on these spreads of changes in market sentiment and risk aversion. We use a sample of both central and peripheral countries from January 1999 to December 2012 and assess whether there were significant changes after the outbreak of the euro area debt crisis. Our results suggest that the rise in sovereign risk in central countries can only be partially explained by the evolution of local macroeconomic variables in those countries. Besides, without exception, the marginal effects of sovereign spread drivers (specifically, the variables that measure global market sentiment) increased during the crisis compared to the pre-crisis period, especially in peripheral countries. Moreover, the increase in the significance of the banking level of indebtedness and foreign bank's claims in the public sector (mainly in peripheral countries) along with the crisis unfolding seems to highlight the interconnection between private and public debt and thus, between banking and sovereign crises.     

Dynamic interactions between Central European currencies and the euro

We argue that the non-euro EU currencies of Central European countries have moved increasingly together with the euro in foreign exchange markets. To prove this point, we examine the dynamics of cross-elasticity between selected Central European currencies (the Czech koruna, Polish zloty, and Hungarian forint) and the euro exchange rates in U.S. dollar terms using daily data for the January 4, 2000 to April 5, 2019 sample period. We adopt the cross-elasticity model originally proposed and tested for the EU currencies by Orlowski (2016). To test the currency co-movements over time, we employ the Bai-Perron multiple breakpoint regression and two-state Markov switching tests. We find evidence of increasing co-movements between the Central European currencies and the euro that become particularly pronounced in times of financial distress. Co-movements of local exchange rates with the euro are also more pronounced during the euro-periphery sovereign debt crisis.     

希腊主权债务危机研究以及对中国的启示

由于处在全球金融危机的时代背景和独特的欧元区经济环境之下,希腊主权债务危机的发生有着自身的特点。对希腊主权债务危机的研究将有助于其他国家防范主权债务危机的发生,对于拥有巨大外汇储备和地方政府债务风险积聚的中国来说,也同样具有积极的意义。     

Soaring corporate debt is a risk to global growth

• ▀ Corporate borrowing is accelerating as a result of the coronavirus crisis. In part, this is a healthy development as firms look to ride out a period of low or even zero sales. But it also brings potential risks to growth, especially in the longer term, including via lengthy balance sheet restructuring that hurts investment and productivity growth.
• ▀ In the advanced economies, we estimate the aggregate corporate debt/GDP ratio could rise as much as 10ppts in 2020, to 95% of GDP - well above the 2009 peak. Debt service ratios may also rise into risky territory despite low interest rates. Risks look especially elevated in France and Canada.
• ▀ Evidence for both advanced and emerging economies suggests high corporate debt levels can damage growth. Highly indebted firms tend to invest less in both the near and medium terms, and some estimates suggest the rise in aggregate debt this year could cut GDP growth by up to 0.2% per year.
• ▀ The coronavirus crisis may also crystallise some pre-existing risks in corporate debt. Despite government assistance, defaults by low-rated firms have started to rise and commercial real estate prices are falling.
• ▀ Sectoral concentrations of risk may also be intensified and new ones created in industries hit hard by the virus like energy and consumer discretionary sectors.
• ▀ Emerging market corporate debt is also on the rise - sharply in some cases. In some economies, this mostly reflects exchange rate effects. But negative balance sheet effects of this kind are also a risk to growth.

     

Financial fragility,sovereign default risk and the limits to commercial bank bail-outs

We show that with intertwined weak banks and weak sovereigns, bank recapitalizations become much less effective. We construct a DSGE model with leverage constrained banks lending to firms and holding domestic government bonds. Bond prices reflect endogenously generated sovereign risk. This introduces a negative amplification cycle: after a credit crisis output losses increase more because higher interest rates trigger lower bond prices and subsequent losses at banks. This further tightens bank leverage constraints, and causes interest rates to rise further. Also bank recapitalizations are then much less effective. Recaps involve swaps of newly issued sovereign bonds for bank equity, the new debt increases sovereign debt discounts, leading to capital losses for the banks on their holdings of sovereign debt that (partially) offset the impact of the recapitalization. The favorable macroeconomic effects of bank recaps on the recovery after a financial crisis are correspondingly lower.     

Sovereign rating changes—Do they provide new information for stock markets?

The purpose of this paper is to examine the impact of sovereign rating changes on international financial markets using a comprehensive database of 42 countries, covering the major regions in the world over the period 1995–2003. In general, we find that rating agencies provide stock and foreign exchange markets with new tradable information. Specifically, rating upgrades (downgrades) significantly increased (decreased) USD denominated stock market returns and decreased (increased) volatility. Whereas the mean response is contributed evenly by the local currency stock returns and exchange rate changes that make up the USD returns, only the foreign exchange volatility was behind the USD denominated return volatility. In addition, we find significant asymmetric effects of rating announcements. The market responses – both return and volatility – are more pronounced in the cases of downgrades, foreign currency debt, emerging market debt, and during crisis periods. This study has important policy implications for international investors’ asset allocation plans and for regulatory bodies such as the Basel Committee who increasingly rely upon Moody's, Standard and Poor's and Fitch's ratings for their regulatory regimes.     

SOVEREIGN INSOLVENCY PROCEDURES – A COMPARATIVE LOOK AT SELECTED PROPOSALS

Abstract.  The most practicable short-term approaches for sovereign debt restructuring would include a code of conduct (voluntary approach) and collective action clauses (contractual approach). In the medium term, a sovereign insolvency procedure (statutory approach) may have an important role to play because it would be a comprehensive instrument designed to coordinate different creditor groups prior to and during a debt crisis. This paper provides a survey of six comprehensive policy proposals for a sovereign bankruptcy procedure. It points to approaches that could improve existing proposals and creates a basis for new proposals which could prove conducive to reaching political consensus.     

Let's fight the next sovereign debt war now

Recent difficulties in Mexico have reminded us of the dangers of financial crisis in heavily indebted countries. In this article, Richard Portes argues that we need to plan now to deal with the next sovereign debt crisis. He proposes a programme of reform to enable an orderly 'work-out'of debt in such situations. This, he argues, is preferable to an expensive bailout or a messy and dangerous default.     

ESTIMATING FISCAL LIMITS: THE CASE OF GREECE

This paper uses Bayesian methods to estimate a real business cycle model that allows for interactions among fiscal policy instruments, the stochastic ‘fiscal limit’ and sovereign default. Using the particle filter to perform likelihood‐based inference, we estimate the full nonlinear model with post‐EMU data until 2010:Q4. We find that (i) the probability of default on Greek debt was in the range of 5–10% in 2010:Q4 and (ii) the 2011 surge in the Greek real interest rate is within model forecast bands. The results suggest that a nonlinear rational expectations environment can account for the Greek interest rate path. Copyright © 2014 John Wiley & Sons, Ltd.     

Euro‐insurance‐bonds: a long‐term solution for the European sovereign debt problem?

This article proposes that all new Euro area sovereign borrowing be in the form of jointly underwritten ‘Euro‐insurance‐bonds’ trading at the same price for outside investors. To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency…     

Banking and sovereign debt crises in a monetary union without central bank intervention

We analyze the conditions of emergence of a twin banking and sovereign debt crisis within a monetary union in which: (i) the central bank is not allowed to provide direct financial support to stressed member states or to play the role of lender of last resort in sovereign bond markets, and (ii) the responsibility of fighting against large scale bank runs, ascribed to domestic governments, is ensured through the implementation of a financial safety net (banking regulation and government deposit guarantee). We show that this broad institutional architecture, typical of the Eurozone at the onset of the financial crisis, is not always able to prevent the occurrence of a twin banking and sovereign debt crisis triggered by pessimistic investors’ expectations. Without significant backstop by the central bank, the financial safety net may actually aggravate, instead of improve, the financial situation of banks and of the government.     

Why Do African Banks Lend So Little?

We put forward a plausible explanation of African banking sector under‐development in the form of a bad credit market equilibrium. Using an appropriately modified Industrial Organization model of banking, we show that the root of the problem could be unchecked moral hazard (strategic loan defaults) or adverse selection (a lack of good projects). Applying a dynamic panel estimator to a large sample of African banks, we show that loan defaults are a major factor inhibiting bank lending when institutional quality is low. We also find that once a threshold level of institutional quality has been reached, improvements in the default rate or institutional quality do not matter. This provides support for our theoretical predictions.     

The great rotation in global credit risks

• ? The pattern of global credit risks looks very different today than in 2007. Risks are now mostly centred in China and emerging markets. “Excess” private debt in China is as high as $3 trillion compared with $1.7 trillion in the US a decade ago. Yet some pockets of significant risk still exist in advanced economies, which not only implies vulnerability to rising interest rates, but also that the scope for rate rises may be limited.
• ? With policy normalisation underway in the US and the scaling back of asset purchases expected to start soon in the Eurozone, we focus on assessing vulnerabilities across global credit markets. This article explores the topic using a top‐down, cross‐country approach. We find that although private debt and debt service ratios look more benign in advanced economies than a decade ago, they have deteriorated markedly in many emerging markets in recent years.
• ? Based on a measure of excess private debt – comparing private credit‐to‐GDP ratios with their trend – China, Hong Kong and Canada are the riskiest. When comparing debt service ratios relative to their long‐term averages, risks are also mainly concentrated in emerging countries. But Canada, Australia and some smaller European countries also have high debt service ratios that have failed to drop since 2007, despite the slump in global interest rates.
• ? Overall, aggregate private debt indicators look less worrying than in 2007. We would also argue that the concentration of excess private debt levels in China reduces the risk of a sudden financial crisis based on massive credit losses, such as the one in 2007–2010. But with corporate debt levels in the US, Canada and some other G7 countries above their long‐term trend, investors need to be attentive to these considerable pockets of risk.

     

The real effects of inflation in a developing economy with external debt and sovereign risk

In this paper we develop an intertemporal optimizing model to examine the real effects of inflation induced by monetary policy in an open developing economy with external debt and sovereign risk. The economy faces an upward sloping supply curve of debt. In our model, households require real balances in advance for consumption expenditures, and monetary policy involves targeting the inflation rate. We show that an increase in the inflation rate leads to a decrease in the stock of foreign debt. It also leads to a decrease in consumption, employment, capital accumulation and output in the long run. Our results show that the accumulation of foreign debt exhibits non-monotonic adjustment. Particularly, an increase in the inflation rate leads to a current account surplus followed by a deficit. Along with this non-monotonicity, our model also explains the positive correlation between savings and investment during the transitional periods (Feldstein–Horioka puzzle).     

Information transmission between sovereign debt CDS and other financial factors ⿿ The case of Latin America

This paper extends previous research by investigating the intertemporal causality relationships between daily Latin America sovereign credit default swap (CDS) returns and other financial sovereign debt spread determinants. The empirical results indicate that information in sovereign CDS can both lead and lag these financial determinants. Specifically, country financial variables, including exchange rates and lending spreads, and global financial variables including 10-U.S. Treasury yields, VIX and TED spreads, are important determinants for future sovereign CDS price movements. The findings provide investment implications for international financial markets.