Sovereign credit ratings,capital flows and financial sector development in emerging markets

How does the sovereign credit ratings history provided by independent ratings agencies affect domestic financial sector development and international capital inflows to emerging countries? We address this question utilizing a comprehensive dataset of sovereign credit ratings from Standard and Poor's from 1995–2003 for a cross-section of 51 emerging markets. Within a panel data estimation framework, we examine financial sector development and the influence of sovereign credit ratings provision, controlling for various economic and corporate governance factors identified in the financial development literature. We find strong evidence that our sovereign credit rating measures do affect financial intermediary sector developments and capital flows. We find that i) long-term foreign currency sovereign credit ratings are important for encouraging financial intermediary development and for attracting capital flows. ii) Long-term local currency ratings stimulate domestic market growth but discourage international capital flows. iii) Short-term ratings (both foreign and local currency denominated) retard all forms of financial developments and capital flows. There are important implications in this research for policy makers to encourage the provision of longer-term credit ratings to promote financial development in emerging economies.     

Sovereign risk and procyclical fiscal policy in emerging market economies

This study develops a dynamic stochastic general equilibrium model to account for the differences in fiscal policy stance over the business cycle between developed and emerging market countries, and, in particular, for the volatile and procyclical government consumption and transfer payment in emerging market countries. Two models with and without default option in sovereign borrowings replicate the contrasting cyclical behaviors indicating that the default option is responsible for procyclical fiscal policy. Further, augmented model with third-party bailouts, together with the stochastic trend income process, successfully predicts high volatilities of fiscal expenditures. These imply that procyclical fiscal policy, entailed by default option, may exacerbate the business cycle in emerging market countries.     

Understanding the sovereign credit ratings of emerging markets

This paper identifies the macroeconomic factors behind the sovereign credit ratings of global emerging markets assigned by Standard and Poor's (S&P). The financial integration and globalization of capital markets have facilitated the capital inflows/outflows among countries. Sovereign credit ratings have served as a signal for countries' economic, financial and political situations. Ratings are very important in the sense that they attract capital inflow and investments. This is especially vital for emerging markets. Although the rating agencies do not explicitly reveal their methodologies, it is possible to guess the effects of several variables on ratings by using various econometric models. Concerning the heavy criticisms on rating agencies' performances, we wish to examine the sovereign credit ratings within a specific country-category. In this essay, we study the effects of macroeconomic factors on the sovereign ratings of emerging markets. Using several approaches, we find that the most relevant factors are Budget Balance/GDP, GDP per capita, Governance Indicators and Reserves/GDP. Moreover, our model predicts up to 93% of all credit rating levels. Interestingly, we obtain that S&P's evaluation of the sovereign credit rating for Turkey performs poorly, especially in the highest rating levels.     

Can exchange seat prices predict financial market volatility?

There is considerable evidence that trading volume and volatility are positively related and that exchange seat prices are largely a function of trading volume. This article examines whether changes in seat prices at the Chicago Board of Trade (where stock index and interest rate futures account for the vast majority of trading volume) are useful in predicting changes in interest rate and stock market volatility. Exponential GARCH and transfer function models are used to demonstrate the power of changes in CBOT seat prices in predicting changes in interest rate and stock market volatility. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:1206–1221, 2008     

Sovereign defaults: Information, investment and credit

Why would a sovereign government, immune from bankruptcy procedures and with few assets that could be seized in the event of a default, ever repay foreign creditors? And, correspondingly, why do foreign creditors lend to sovereigns? This paper finds general conditions under which, even in the absence of sanctions, lending to sovereigns can emerge in a single shot game. Furthermore, it shows that positive borrowing can be sustained both in pooling and separating equilibria. In this way, it makes clear that neither sanctions nor reputation considerations, the two classical explanations, are necessary to enforce repayment. Information revelation is the crucial mechanism for these results. The repayment/default decision is interpreted as a signal used by the government to communicate information to domestic and foreign agents about the fundamentals of the economy. Governments repay to affect agents' expectations about them. A default, through its effect on expectations about fundamentals, can generate a decline in foreign and domestic investment and a credit crunch in domestic credit markets. Governments repay to avoid these costs, but may default (in equilibrium) when hit by a negative shock.     

Emerging market bond spreads and sovereign credit ratings: reconciling market views with economic fundamentals

This paper uses a panel data estimation of a simple univariate model of sovereign spreads on ratings to analyze statistically significant differences between actual spreads and ratings-based spreads. When such deviations are significant, we find that ‘excessively high’ spreads are on average followed by episodes of spread tightening 1 month later rather than credit downgrades. In contrast, observations with ‘excessively low’ spreads are on average followed by rating upgrades 3 months later rather than episodes of spread widening. The paper also illustrates how significant disagreements between market and rating agencies’ views can be used as a signal that further technical and sovereign analysis is warranted. For instance, we find that spreads were ‘excessively low’ for most emerging markets before the Asian crisis. More recently, spreads were ‘excessively high’ for a number of emerging markets.     

Asymmetric linkages among the fear index and emerging market volatility indices

This study explores the relationships between changes in the fear index (VIX) and changes in emerging market volatilities i.e., Chinese, Brazilian and the overall emerging volatility index, across their conditional distributions by employing a mixed Quantile regression - Copula methodological approach. Moreover, we analyze whether emerging market volatility indices would respond asymmetrically to positive and negative volatility shocks in the fear index i.e., whether the relationships are asymmetric between the VIX and the emerging market volatilities. Our results confirm that there are strong positive relationships between changes in the VIX and emerging market volatilities, and the linkages tend to be stronger for the upper-parts of the conditional distributions, namely above the median-quantiles up to the extreme-quantiles. In all cases, the nature of the relationship appears to be contemporaneous and on average is three times stronger than their lagged relationship. Further test results reveal that the relationship is highly asymmetric i.e., the effect of a positive shock in the VIX is on average about twice more pronounced than the effect of a negative shock at the extreme-tails of their conditional distributions, a stylized fact that cannot be revealed via conventional estimation methods as OLS. If we compare the effects of positive and negative VIX shocks on emerging market volatilities utilizing QRM, Copulas and OLS, our findings reveal that the effect of a positive shock by the QRM at the 95% quantile is about eight times higher than the one revealed by OLS. An exhaustive robustness analysis is also performed with respect to other volatility measures.     

Return and price volatility of bonds with different credit risk

This article analyzes the relative price and monthly holding period return volatility of bonds with differing credit risk. The research proceeds by decomposing the causes of price volatility into that due to duration and yield volatility. Lower duration, due to higher coupon rate, and relatively stable yields, due to the behavior of credit risk and risk aversion over the business cycle, may well make lower quality issues such as A and Baa industrials exhibit less volatility than high-quality issues such as Aaa industrials and United States Treasury issues.     

Assessing credit quality from the equity market: can a structural approach forecast credit ratings?

We investigate the empirical performance of default probability prediction based on Merton's (1974) structural credit risk model. More specifically, we study if distance‐to‐default is a sufficient statistic for the equity market information concerning the credit quality of the debt‐issuing firm. We show that a simple reduced form model outperforms the Merton (1974) model for both in‐sample fitting and out‐of‐sample predictability for credit ratings, and that both can be greatly improved by including the firm's equity value as an additional variable. Moreover, the empirical performance of this hybrid model is very similar to that of the simple reduced form model. As a result, we conclude that distant‐to‐default alone does not adequately capture the firm's credit quality information from the equity market. Copyright © 2007 ASAC. Published by John Wiley & Sons, Ltd.     

Capital flows,current account deficits,and financial crises in emerging market economies

Some emerging market economies are said to face today conditions similar to those faced by Mexico in 1994 at the time of its serious financial crisis. This paper identifies a number of macroeconomic and financial indicators, constructs a profile of the Mexican economy at the time of the crisis, and then compares these with the conditions in other major emerging market economies in Latin America and Asia today in order to determine the extent to which they resemble those of Mexico at the time of the 1994 crisis. The conclusion is reached that macroeconomic and financial indicators cannot by themselves predict Mexican-style financial crises. In today's world of highly integrated capital markets, any anticipation of financial unsustainability can lead to a massive capital outflow from the nation and trigger a crisis, with the catalyst usually being a worsening political problem. The usefulness of the indicators discussed is in providing a profile of the financial condition of the nation, evaluating the potential danger of a financial crisis, anticipating the depth of the crisis if one arises, and pointing to the precautions that a nation can take in trying to avoid a crisis or reduce its severity if one does occur.     

Experience-based corporate corruption and stock market volatility: Evidence from emerging markets

This paper reassesses how “experience-based” corporate corruption affects stock market volatility in 14 emerging markets. We match the World Bank enterprise-level data on bribes with a unique cross-country macroeconomics dataset obtained from the World Bank development indicators. It is found that wider coverage of “realized” corporate corruption in the emerging markets investigated reduces the stock market volatility, attributed to decrease in uncertainty about government policy with regard to the business environment, as implied by the general equilibrium model of Pastor and Veronesi (2012). Overall, our results suggest that stock price volatility decreases as the uncertainty about government policy becomes more predictable, which is consistent with the testable hypotheses of Pastor and Veronesi (2012).     

Impact of terrorist attacks on stock market volatility in emerging markets

We use an event study methodology alongside an improved bootstrapping test to evaluate the impact of terrorist attacks on the volatility of stock markets in 12 MENA countries, and test for regional financial integration. Results show that the impact of terrorist attacks on financial markets' volatility lasts about 20 trading days, which is considered to be long compared to the term effect of similar events in developed markets. Moreover, we find evidence of regional financial integration. Our robustness check shows that the bootstrapping approach is more robust, and that theoretical p-values might be misleading if underlying assumptions are violated.     

Stock market,credit market,and heterogeneous innovations

The relative importance of credit market development and stock market development in boosting innovation remains a long-standing debate issue. In this study, we document how different types of financial markets development affect heterogeneous innovations. Using a broad sample across 42 developed and emerging economies and a generalized difference-in-differences identification strategy, we find that stock market development leads to significantly higher substantive innovation, especially in young and small firms, but has negative impact on incremental innovation. Conversely, credit market development promotes incremental innovation, especially in mature and large firms, but has negative impact on substantive innovation. Further analyses indicate that stronger shareholder protection enhances the positive impact of stock market on substantive innovation, while stronger creditor rights enhance the promoting effect of credit market on incremental innovation, and even turn the negative impact of credit market on substantive innovation into positive. Our paper provides new insights into the heterogeneous effects of credit market and equity markets on the real economy.     

The rise of dollar credit in emerging market economies and US monetary policy

This paper examines the hypothesis that the boom in dollar credit in emerging market economies (EMEs) is associated with an excessively low interest rate in the US. For this purpose, we use a multivariate correlated unobserved component model that allows for correlation between shocks to dollar credit, cross‐border interest rate gaps—measured as the difference between emerging market interest rate and the US interest rate, and dollar index both in the short run and in the long run. In addition, it also provides us a quantitative estimate of the permanent and transitory movements in dollar credit in EMEs, interest rate gaps and dollar index. The results from this model do suggest that a temporary increase in interest rate gaps and decline in the dollar index are associated with a temporary increase in the dollar credit in EMEs with a very high degree of correlation. The estimate of the cyclical component of the dollar credit in EMEs from our model captures the recent boom and bust in this market and compares favourably to alternative trend–cycle decomposition methods.     

论国际金融市场一体化与发展中国家金融风险防范

一、国际金融市场一体化的形成及影响 (一)国际金融市场一体化的形成 20世纪50年代末60年代初以来,随着国际经济的发展、金融技术的进步,尤其是80年代以来世界各国金融自由化(利率自由化、汇率自由化、银行业务自由化、金融市场自由化、资本流动自由化等)措施也直接推动了国际金融市场一体化的进程。各国国内和国外金融市场之间的日益紧密的联系、协调,它们相互影响、相互促进,逐步走向一个统一的金融市场的状态和趋势。     

Sovereign default, interest rates and political uncertainty in emerging markets

A large body of the empirical literature shows that high turnover rates/length of tenure of policymakers and the degree of conflict within a country affects sovereign spreads, debt and default rates. We help to rationalize such claims by including these political features in a dynamic stochastic small open economy model of sovereign debt and default. In this way we offer a complementary approach to the econometric analyses in the literature. Consistent with the data, the quantitative analysis shows that politically unstable and more polarized economies experience higher default rates and larger level and volatility of sovereign interest rate spreads.