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Article
Publication date: 20 November 2020

Gabriel Caldas Montes and Julyara Costa

Since sovereign ratings provided by credit rating agencies (CRAs) are a key determinant of the interest rates a country faces in the international financial market and…

Abstract

Purpose

Since sovereign ratings provided by credit rating agencies (CRAs) are a key determinant of the interest rates a country faces in the international financial market and once sovereign ratings may have a constraining impact on the ratings assigned to domestic banks or companies, some studies have focused on identifying the determinants of sovereign credit risk assessments provided by CRAs. In particular, this study estimates the effect of fiscal credibility on sovereign risk using four different comprehensive credit rating (CCR) measures obtained from CRAs' announcements and two different fiscal credibility indicators.

Design/methodology/approach

We build comprehensive credit rating (CCR) measures to capture sovereign risk. These measures are calculated using sovereign ratings, the rating outlooks and credit watches issued by the three main credit rating agencies (S&P, Moody's and Fitch) for long-term foreign-currency Brazilian bonds. Based on monthly data from 2003 to 2018, we use different econometric estimation techniques in order to provide robust results.

Findings

The results indicate that fiscal credibility exerts both short- and long-run effects on sovereign risk perception, and macroeconomic fundamentals are important long-run determinants.

Practical implications

Since fiscal credibility reflects the government's ability to maintain budgetary balance and sustainable public debt, the government should keep its commitment to responsible fiscal policies so as not to deteriorate expectations formed by financial market experts about the fiscal scenario and, thus, to achieve better credit assessments issued by CRAs with respect to sovereign debt bonds. Sovereign credit rating assessment is a voluntary practice. It is up to the country whether they want to apply for a rating assessment or not. Thus, without a sovereign rating, one must find an alternative to measure the sovereign risk of a country. In this sense, an important practical implication that this study provides is that fiscal credibility can be used as a leading indicator of sovereign risk perceptions obtained from CRAs or even as a proxy for sovereign risk.

Originality/value

This paper is the first to verify how important the expectations of financial market experts in relation to the fiscal effort required to keep public debt at a sustainable level (i.e. fiscal credibility) are to sovereign risk perception of credit rating agencies. In this sense, the study is the first to address this relation, and thus it contributes to the literature that seeks to understand the determinants of sovereign ratings in emerging countries.

Details

International Journal of Emerging Markets, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1746-8809

Keywords

Content available
Article
Publication date: 19 November 2018

Rick van de Ven, Shaunak Dabadghao and Arun Chockalingam

The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust…

Abstract

Purpose

The credit ratings issued by the Big 3 ratings agencies are inaccurate and slow to respond to market changes. This paper aims to develop a rigorous, transparent and robust credit assessment and rating scheme for sovereigns.

Design/methodology/approach

This paper develops a regression-based model using credit default swap (CDS) data, and data on financial and macroeconomic variables to estimate sovereign CDS spreads. Using these spreads, the default probabilities of sovereigns can be estimated. The new ratings scheme is then used in conjunction with these default probabilities to assign credit ratings to sovereigns.

Findings

The developed model accurately estimates CDS spreads (based on RMSE values). Credit ratings issued retrospectively using the new scheme reflect reality better.

Research limitations/implications

This paper reveals that both macroeconomic and financial factors affect both systemic and idiosyncratic risks for sovereigns.

Practical implications

The developed credit assessment and ratings scheme can be used to evaluate the creditworthiness of sovereigns and subsequently assign robust credit ratings.

Social implications

The transparency and rigor of the new scheme will result in better and trustworthy indications of a sovereign’s financial health. Investors and monetary authorities can make better informed decisions. The episodes that occurred during the debt crisis could be avoided.

Originality/value

This paper uses both financial and macroeconomic data to estimate CDS spreads and demonstrates that both financial and macroeconomic factors affect sovereign systemic and idiosyncratic risk. The proposed credit assessment and ratings schemes could supplement or potentially replace the credit ratings issued by the Big 3 ratings agencies.

Details

The Journal of Risk Finance, vol. 19 no. 5
Type: Research Article
ISSN: 1526-5943

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Article
Publication date: 21 August 2017

Mariya Gubareva and Maria Rosa Borges

The purpose of this paper is to study connections between interest rate risk and credit risk and investigate the inter-risk diversification benefit due to the joint…

Abstract

Purpose

The purpose of this paper is to study connections between interest rate risk and credit risk and investigate the inter-risk diversification benefit due to the joint consideration of these risks in the banking book containing sovereign debt.

Design/methodology/approach

The paper develops the historical derivative-based value at risk (VaR) for assessing the downside risk of a sovereign debt portfolio through the integrated treatment of interest rate and credit risks. The credit default swaps spreads and the fixed-leg rates of interest rate swap are used as proxies for credit risk and interest rate risk, respectively.

Findings

The proposed methodology is applied to the decade-long history of emerging markets sovereign debt. The empirical analysis demonstrates that the diversified VaR benefits from imperfect correlation between the risk factors. Sovereign risks of non-core emu states and oil producing countries are discussed through the prism of VaR metrics.

Practical implications

The proposed approach offers a clue for improving risk management in regards to banking books containing government bonds. It could be applied to access the riskiness of investment portfolios containing the wider spectrum of assets beyond the sovereign debt. The approach represents a useful tool for investigating interest rate and credit risk interrelation.

Originality/value

The proposed enhancement of the traditional historical VaR is twofold: usage of derivative instruments’ quotes and simultaneous consideration of the interest rate and credit risk factors to construct the hypothetical liquidity-free bond yield, which allows to distil liquidity premium.

Details

The Journal of Risk Finance, vol. 18 no. 4
Type: Research Article
ISSN: 1526-5943

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Book part
Publication date: 16 August 2014

Gaiyan Zhang

This chapter provides a comprehensive overview of the young, but rapidly growing sovereign credit default swap (CDS) market, describes the function, trading, history…

Abstract

This chapter provides a comprehensive overview of the young, but rapidly growing sovereign credit default swap (CDS) market, describes the function, trading, history, market participants, key statistical and stylized facts about CDS prices, determinants, price discovery, and risk issues.

Details

International Financial Markets
Type: Book
ISBN: 978-1-78190-312-4

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Article
Publication date: 21 November 2014

Christina E. Bannier, Thomas Heidorn and Heinz-Dieter Vogel

This paper aims to provide an overview of the market for corporate and sovereign credit default swaps (CDS), with particular focus on Europe. It studies whether the…

Abstract

Purpose

This paper aims to provide an overview of the market for corporate and sovereign credit default swaps (CDS), with particular focus on Europe. It studies whether the subprime crisis of 2007/2008 and, particularly, the European debt crisis 2009/2010 led to a differential development on corporate and sovereign CDS markets and investigates the primary use (speculative risk-trading or risk-hedging) of the two markets in recent years.

Design/methodology/approach

The authors use aggregate market data on the size of the respective markets and on the structure of market participants and their changes over time to assess the main research question. They enhance existing data from public sources such as the Bank for International Settlements and Depository Trust and Clearing Corporation with their own statistics on European sovereign CDS and combine their conclusions with observations regarding standardisation efforts and regulatory changes in the CDS market.

Findings

The authors show that after the subprime crisis 2007/2008 and the European debt crisis 2009/2010, the corporate and sovereign CDS markets developed quite differently. They provide evidence that since mid-2010, market participants started to use the sovereign CDS market more strongly for speculative purposes than for risk-hedging. This shows both in the shift of risk-quality of sovereign CDS contracts and in the changing structure of market participants. The ongoing standardisation and regulation in the CDS market – leading to further increases in transparency and reductions in transaction costs – may be expected to trigger a similar change also for corporate CDS.

Originality/value

Based on a broad variety of market infrastructure data, the authors show a diverging development of corporate and sovereign CDS markets in Europe in recent years. Particularly the sovereign CDS market appears to have shifted from a risk-hedging instrument to being used more strongly for speculative risk-trading. The authors combine their findings with recent regulatory action and market standardisation schemes and draw conclusions for the future development of CDS markets.

Details

The Journal of Risk Finance, vol. 15 no. 5
Type: Research Article
ISSN: 1526-5943

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Article
Publication date: 12 June 2017

Zuziwe Ntsalaze, Gideon Boako and Paul Alagidede

The purpose of this paper is to examine the impact of sovereign credit ratings on corporations in South Africa by assessing whether the sovereign rating assigned to South…

Abstract

Purpose

The purpose of this paper is to examine the impact of sovereign credit ratings on corporations in South Africa by assessing whether the sovereign rating assigned to South Africa by credit rating agencies acts as a ceiling/constraint for credit ratings assigned to corporations that operate within the country. The question of whether sovereign ratings are significant in determining corporate ratings was also explored.

Design/methodology/approach

To test the hypothesis regarding the rating of corporates relative to sovereigns, a longitudinal panel design was followed. The analysis employed fixed effects and generalized method of moments techniques.

Findings

The main findings are that sovereign ratings both act as a ceiling for corporate ratings and are important determinants of corporate ratings in South Africa. The findings however indicated that company specific variables (accounting variables) are not significant in explaining credit risk ratings assigned to corporates.

Research limitations/implications

This study only looked at the rating activity done by Standard and Poor’s (S&P). A possible further study could explore the hypothesis tested in this research using data from multiple rating agencies and contrast the results across different agencies. Future studies could also look at crisis periods and how the transfer risk discussed in this paper manifests during the transfer period.

Practical implications

The results have implications for the borrowing costs incurred by corporates in South Africa when participating in the international debt market. The implication is that if the sovereign is poorly rated, the corporates may be limited in their ability to secure investor funding at competitive rates from the international financial markets. Thus, should South Africa be downgraded to non-investment grade by S&P, the implications may be that South African corporates on average may suffer the same fate.

Originality/value

Extant literature predominantly utilizes foreign currency ratings. To the extent that this study uses local currency ratings, it adds a new dimension in the body of related studies.

Details

African Journal of Economic and Management Studies, vol. 8 no. 2
Type: Research Article
ISSN: 2040-0705

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Article
Publication date: 14 May 2020

Misheck Mutize and McBride Peter Nkhalamba

This study is a comparative analysis of the magnitude of economic growth as a key determinant of long-term foreign currency sovereign credit ratings in 30 countries in…

Abstract

Purpose

This study is a comparative analysis of the magnitude of economic growth as a key determinant of long-term foreign currency sovereign credit ratings in 30 countries in Africa, Europe, Asia and Latin America from 2010 to 2018.

Design/methodology/approach

The analysis applies the fixed effects (FE) and random effects (RE) panel least squares (PLS) models.

Findings

The authors find that the magnitude economic coefficients are marginally small for African countries compared to other developing countries in Asia, Europe and Latin America. Results of the probit and logit binary estimation models show positive coefficients for economic growth sub-factors for non-African countries (developing and developed) compared to negative coefficients for African countries.

Practical implications

These findings mean that, an increase in economic growth in Africa does not significantly increase the likelihood that sovereign credit ratings will be upgraded. This implies that there is lack of uniformity in the application of the economic growth determinant despite the claims of a consistent framework by rating agencies. Thus, macroeconomic factors are relatively less important in determining country's risk profile in Africa than in other developing and developed countries.

Originality/value

First, studies that investigate the accuracy of sovereign credit rating indicators and risk factors in Africa are rare. This study is a key literature at the time when the majority of African countries are exploring the window of sovereign bonds as an alternative funding model to the traditional concessionary borrowings from multilateral institutions. On the other hand, the persistent poor rating is driving the cost of sovereign bonds to unreasonably high levels, invariably threatening their hopes of diversifying funding options. Second, there is criticism that the rating assessments of the credit rating agencies are biased in favour of developed countries and there is a gap in literature on studies that explore the whether the credit rating agencies are biased against African countries. This paper thus explores the rationale behind the African Union Decision Assembly/AU/Dec.631 (XXVIII) adopted by the 28th Ordinary Session of the African Union held in Addis Ababa, Ethiopia in January 2017 (African Union, 2017), directing its specialized governance agency, the African Peer Review Mechanism (APRM), to provide support to its Member States in the field of international credit rating agencies. The Assembly of African Heads of State and Government highlight that African countries are facing the challenges of credit downgrades despite an average positive economic growth. Lastly, the paper makes contribution to the argument that the majority of African countries are unfairly rated by international credit rating agencies, raising a discussion of the possibility of establishing a Pan-African credit rating institution.

Details

International Journal of Emerging Markets, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 1746-8809

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Book part
Publication date: 1 July 2015

Willi Semmler and Christian R. Proaño

The recent financial and sovereign debt crises around the world have sparked a growing literature on models and empirical estimates of defaultable debt. Frequently…

Abstract

The recent financial and sovereign debt crises around the world have sparked a growing literature on models and empirical estimates of defaultable debt. Frequently households and firms come under default threat, local governments can default, and recently sovereign default threats were eminent for Greece and Spain in 2012–2013. Moreover, Argentina experienced an actual default in 2001. What causes sovereign default risk, and what are the escape routes from default risk? Previous studies such as Arellano (2008), Roch and Uhlig (2013), and Arellano et al. (2014) have provided theoretical models to explore the main dynamics of sovereign defaults. These models can be characterized as threshold models in which there is a convergence toward a good no-default equilibrium below the threshold and a default equilibrium above the threshold. However, in these models aggregate output is exogenous, so that important macroeconomic feedback effects are not taken into account. In this chapter, we (1) propose alternative model variants suitable for certain types of countries in the EU where aggregate output is endogenously determined and where financial stress plays a key role, (2) show how these model variants can be solved through the Nonlinear Model Predictive Control numerical technique, and (3) present some empirical evidence on the nonlinear dynamics of output, sovereign debt, and financial stress in some euro areas and other industrialized countries.

Details

Monetary Policy in the Context of the Financial Crisis: New Challenges and Lessons
Type: Book
ISBN: 978-1-78441-779-6

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Article
Publication date: 24 August 2020

Diego Silveira Pacheco de Oliveira and Gabriel Caldas Montes

Credit rating agencies (CRAs) are perceived as highly influential in the financial system since their announcements can affect several players in the financial markets…

Abstract

Purpose

Credit rating agencies (CRAs) are perceived as highly influential in the financial system since their announcements can affect several players in the financial markets, from big private financial and non-financial companies and their financial markets experts to sovereign states. In this sense, this study investigates whether sovereign credit news issued by CRAs (measured by comprehensive credit rating (CCR) variables) affect the uncertainties about the exchange rate in the future (captured by the disagreement about exchange rate expectations). The study is relevant once there is evidence indicating that CRAs' assessments are responsible for affecting international capital flows and, thus, sovereign rating changes can affect the expectations formation process regarding the exchange rate. In addition, there is evidence indicating that the disagreement about exchange rate expectations affects the disagreement about inflation expectations, which brings consequences to policymakers.

Design/methodology/approach

The dependent variables are the disagreement in expectations about the Brazilian exchange rate for different forecast horizons, 12, 24 and 36 months ahead and the first principal component of theses series. On the other hand, the CCR variables are built upon the long-term foreign-currency Brazilian bonds ratings, outlooks and credit watches provided by the main CRAs. Estimates are obtained using ordinary least squares (OLS) and generalized method of moments (GMM); a dynamic analysis is performed using vector-autoregressive (VAR) through impulse-response functions.

Findings

Negative (positive) sovereign credit news, given by a rating downgrade (upgrade) and/or a negative (positive) outlook/watch status, increase (decrease) the disagreement about exchange rate expectations. This result holds for all disagreement and CCR variables.

Practical implications

The study brings practical implications to both private agents (mainly financial market experts) and policymakers. An important practical implication of the study concerns the ability of CRAs to affect the expectations formation process of financial market experts regarding the future behavior of the exchange rate. When a CRA issues a signal of improvement in a country's sovereign rating, this signal reflects the perception of improvement in macroeconomic fundamentals and reduction of uncertainties about the country's ability to honor its financial obligations, which therefore, facilitates the expectations formation process, causing a reduction in the disagreement about the exchange rate expectations. With respect to the consequences for policymakers, they will have more difficulty in guiding expectations in a country with a worse sovereign risk rating, where agents have difficulties in forming expectations and the disagreement in expectations is greater.

Originality/value

The study is the first to analyze the impact of CRAs' announcements on the disagreement about exchange rate expectations. Moreover, it connects the literature that investigates the effects of sovereign credit news on the economy with the literature that examines the main determinants of disagreement in expectations about macroeconomic variables.

Details

Journal of Economic Studies, vol. ahead-of-print no. ahead-of-print
Type: Research Article
ISSN: 0144-3585

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Article
Publication date: 16 October 2009

Kam C. Chan, Hung‐Gay Fung and Gaiyan Zhang

When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices…

Abstract

When extended to sovereign issuers, the Merton‐type structural model suggests a negative relationship between sovereign credit default swap (CDS) spreads and stock prices. In practice, capital structure arbitrage that exploits such relationships should foster the integration of CDS and the stock market and improve price discovery. This paper studies the dynamic relationship between sovereign CDS spreads and stock prices for seven Asian countries for the period from January 2001 to February 2007. We find a strong negative correlation between the CDS spread and the stock index for most Asian countries. A long‐run equilibrium price relationship is found for China, Korea, and Thailand. The limited integration in other countries may arise from market frictions and model applicability. In terms of price discovery, CDS markets play a leading role in five out of seven countries. Therefore, equity investors should span the CDS market for incremental information. The stock market has a feedback effect for two countries and dominates price discovery for only one country.

Details

Journal of Asia Business Studies, vol. 4 no. 1
Type: Research Article
ISSN: 1558-7894

Keywords

1 – 10 of over 2000