The pricing of bonds and bank loans in international markets: An empirical analysis of developing countries' foreign borrowing

Most recent empirical studies on creditworthiness and country risk have dealt with the international bank loan market, and have ignored the bond market in their effort to analyze the process of determination of default risk premia. In this paper data on both bank loans to the LDCs and on bonds issued by LDCs are used to analyze empirically several aspects related to developing countries' foreign borrowing and country risk. The paper analyzes three basic problems. First, some of the more important implications of modern models of LDCs foreign borrowing are tested. In particular the supposed positive effect of the level of indebtedness on the risk premium is investigated. Second, the pricing of bonds and bank loans are explicitly compared, in order to test whether, as sometimes has been argued, these two markets are significantly different. And third, data on yields on LDC bonds in the secondary market are analyzed to investigate the extent to which the market anticipated the debt crisis, and how it reacted to it.The main results obtained can be summarized as follows: First, both the bank loans and bonds data confirm some of the more important implications of foreign borrowing models. Specifically, the positive effect of higher debt ratios on the risk premium is confirmed. Second, it is found that the pricing of bonds and bank loans has somewhat differed. And third, it is found that the market anticipated by only a few weeks — and only partially — the world debt crisis of 1982. Finally, some policy implications that emerge from these findings are discussed.