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Book part
Publication date: 16 August 2014

Yan Alice Xie, Jot Yau and Hei Wai Lee

The study examines the joint effect of sovereign and call risks on the duration of callable sovereign bonds over the period 1996–2011. The results indicate that the sovereign risk

Abstract

The study examines the joint effect of sovereign and call risks on the duration of callable sovereign bonds over the period 1996–2011. The results indicate that the sovereign risk-adjusted duration is significantly shorter than its Macaulay counterpart for U.S. dollar-denominated investment-grade callable sovereign bonds. Further, the “shortening” effect of sovereign and call risks on duration is generally stronger among bonds of lower ratings. Similar results are obtained when CDS prices are used as a proxy for changes in sovereign risk. Results from this study emphasize the importance of considering the joint effect of sovereign and call risks in managing the interest rate risk exposure in fixed income investments.

Details

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

Keywords

Open Access
Article
Publication date: 17 August 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 credit…

1394

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

Keywords

Article
Publication date: 14 May 2021

Ioannis Katsampoxakis

The paper examines the impact of the deteriorating fiscal conditions of Eurozone countries on spillover effects on bank credit margins. It is investigated whether these effects…

Abstract

Purpose

The paper examines the impact of the deteriorating fiscal conditions of Eurozone countries on spillover effects on bank credit margins. It is investigated whether these effects have been reduced after European Central Bank’s (ECB) signaling of pursuing an expansionary, unconventional, monetary policy to address the debt crisis in Eurozone.

Design/methodology/approach

A general econometric panel model is applied to investigate spillover effects between Eurozone countries and bank credit margins. In total, three periods are examined: the period before the peak of the global financial crisis and the beginning of the Irish banking crisis, the period during the debt and bank crisis in Eurozone and the period after ECB's signaling of extremely aggressive monetary easing.

Findings

According to empirical results, before the peak of the global financial crisis there was no substantial credit risk transfer from Eurozone sovereigns to banks. During the period of debt and bank crisis in Eurozone, the deterioration of the fiscal situation of Eurozone countries had a significant impact on bank Credit Default Swap (CDS) spreads. After ECB's signaling of extremely aggressive monetary easing, it does not seem to be any significant relationship between Eurozone sovereigns and bank CDS spreads. These findings reinforce the assessment that ECB's measures were effective, achieving the key objective of normalizing economic conditions and ensuring financial stability in Eurozone.

Research limitations/implications

A question is whether effects can change when the corresponding contraction will lead to a reinstatement of “normal” conditions. Would there be a reversal of risk premium trends in bond markets? Although the answer from casual observations seems to be negative, it is a valid research question to be examined. An interesting issue concerning the unconventional monetary policy measures implemented by ECB concerns the issues of moral hazard that they incorporate, something that could not be addressed. Another research perspective could be the use of the beta coefficient to measure the systematic and unsystematic risk of banking sector shares.

Practical implications

The results have strong implications for ECB and European banking regulation. Regulators should mainly pay more attention to the amount and concentration of sovereign debt held by banks. Eurozone financial system could be less vulnerable to the sovereign credit risk. It raised the critical question of whether a more strict regulation is needed. Regulators should not intervene if not necessary, but they must prevent the transmission of crises between markets. This will likely bring trust to the developed countries' sovereign debt and the portfolios of the financial institutions, which hold most of this debt will be considered safe as well.

Social implications

The conclusions provide a safe counterweight in various respects. First, the negative effects and the need to rapidly cease or limit such policies. Second, the financial stability aimed by ECB. Such policies contain the possibility of a subsequent moral hazard related to Member State and bank behavior. However, these contingencies need to be assessed with the benefits resulting from the restoration of financial markets and the disconnection between banking and sovereign credit risk. This leads Eurozone's financial system to become less vulnerable to the sovereign credit risk and therefore more safe, helping to restore confidence in the real economy.

Originality/value

Contribution in terms of methodology and conclusions. It offers important conclusions regarding the limitations of yields and volatility of CDS spreads. It examines the spillover effects of the fiscal situation of Eurozone countries on banking institutions by extending the existing methodology and introducing new questions focusing on the reaction of CDS market to the ECB monetary policy, the reduction of risk premiums at sovereign and banking level and the gradual reduction of interdependence between them.

Details

EuroMed Journal of Business, vol. 17 no. 2
Type: Research Article
ISSN: 1450-2194

Keywords

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 subprime…

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

Keywords

Article
Publication date: 11 May 2021

Filippo Gori

This paper aims to investigate the nexus between banks’ foreign assets and sovereign default risk in a panel of 15 developed economies. The empirical evidence suggests that banks’…

Abstract

Purpose

This paper aims to investigate the nexus between banks’ foreign assets and sovereign default risk in a panel of 15 developed economies. The empirical evidence suggests that banks’ foreign exposure is an important determinant of sovereign default probability.

Design/methodology/approach

Using data from the consolidated banking statistics (total foreign claims on ultimate risk basis) by the Bank of International Settlements, the author constructs a measure of bank international exposure to peer countries. This measure is then used as the target variable in a panel regression for sovereign credit default swaps. The model includes 15 European and non-European developed economies. Identification is discussed extensively in the paper.

Findings

Quantitatively, a 1% increase in banks’ cross-border claims increases sovereign default risk by about 0.19%. The relationship is weaker when banks are more capitalised. On the other hand, governments are more vulnerable to credit risk spillovers from banks’ international portfolios when having higher debt to GDP ratios.

Originality/value

To the best of the author’s knowledge, this is the first paper that attempts explicitly to establish an empirical connection between banks’ international assets and sovereign default risk. To the author’s opinion, this paper represents a contribution to our understanding of how sovereign credit risk spills over across countries. It also extends significantly the existing literature on the determinants of sovereign risk (that primarily focused on fundamentals, market characteristics – such as liquidity – and global factors). This paper ultimately sheds some new light on the role of intermediaries in the international transmission of credit risk, also adding to today’s discussion about the linkages between banks and sovereigns.

Details

Journal of Financial Economic Policy, vol. 13 no. 4
Type: Research Article
ISSN: 1757-6385

Keywords

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 once…

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. 17 no. 3
Type: Research Article
ISSN: 1746-8809

Keywords

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 consideration…

1373

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

Keywords

Article
Publication date: 6 April 2012

James R. Barth, Apanard (Penny) Prabha and Greg Yun

The purpose of this paper is to discuss and then analyze the interdependency between bank and sovereign risk before, during and after the financial crisis.

1529

Abstract

Purpose

The purpose of this paper is to discuss and then analyze the interdependency between bank and sovereign risk before, during and after the financial crisis.

Design/methodology/approach

The authors' approach is based upon an examination of 44 large banks headquartered in 13 countries; eight of these countries belong to the European Union, seven belong to the eurozone, and the remaining five belong to neither group. This provides a good comparison group of countries.

Findings

Evidence is found supporting the existence of significant bank and sovereign risk linkages. There are, however, different patterns in the relationships across countries and even across banks within the same country. Also, higher correlations between bank and sovereign risk are found in countries in which the ratio of the assets of banks relative to their home country's GDP is relatively high.

Research limitations/implications

Based upon the empirical results, allowing banks to invest in sovereign debt without requiring them to hold any capital against the “truerisk of such debt increases the likelihood of insolvency. This means that interdependencies between bank and sovereign risk are extremely important when setting regulatory capital requirements and considering whether action is needed to limit any increase in the likelihood of contagion.

Originality/value

The paper provides a new examination of the interdependencies between individual bank risk and the sovereign risk of the countries in which they are headquartered, with special emphasis on the recent global financial and eurozone crises.

Details

Journal of Financial Economic Policy, vol. 4 no. 1
Type: Research Article
ISSN: 1757-6385

Keywords

Article
Publication date: 13 May 2021

Supriyo De, Sanket Mohapatra and Dilip Ratha

Relative risk ratings measure the degree by which a country’s sovereign rating is better or worse than other countries (Basu et al., 2013). However, the literature on the impacts…

Abstract

Purpose

Relative risk ratings measure the degree by which a country’s sovereign rating is better or worse than other countries (Basu et al., 2013). However, the literature on the impacts of sovereign ratings on capital flows has not covered the role of relative risk ratings. This paper aims to examine the effect of relative risk ratings on private capital flows to emerging and frontier market economies is filled. In the analysis, the effect of relative risk ratings to that of absolute sovereign ratings in influencing private capital flows are compared.

Design/methodology/approach

This paper examines the influence of sovereign credit ratings and relative risk ratings on private capital flows to 26 emerging and frontier market economies using quarterly data for a 20-year period between 1998 and 2017. A dynamic panel regression model is used to estimate the relationship between ratings and capital flows after controlling for other factors that can influence capital flows such as growth and interest rate differentials and global risk conditions.

Findings

The analysis finds that while absolute sovereign credit ratings were an important determinant of net capital inflows prior to the global financial crisis in 2008, the influence of relative risk ratings increased in the post-crisis period. The post-crisis effect of relative ratings appears to be driven mostly by portfolio flows. The main results are robust to an alternate measure of capital flows (gross capital flows instead of net capital flows), to the use of fixed gross domestic product weights in calculating relative risk ratings and to the potential endogeneity of absolute and relative ratings.

Originality/value

This study advances the literature on being the first attempt to understand the impact of relative risk ratings on capital flows and also comparing the impact of absolute sovereign ratings and relative risk ratings on capital flows in the pre- and post-global financial crisis periods. The findings imply that emerging and frontier markets need to pay greater attention to their relative economic performance and not just their sovereign ratings.

Details

Studies in Economics and Finance, vol. 38 no. 4
Type: Research Article
ISSN: 1086-7376

Keywords

Article
Publication date: 6 June 2016

Erwin Hansen and Jennifer Zegarra

The purpose of this paper is to explore the relationship between six different dimensions of political risk in a country and its spread for a sample of 12 Latin American countries.

Abstract

Purpose

The purpose of this paper is to explore the relationship between six different dimensions of political risk in a country and its spread for a sample of 12 Latin American countries.

Design/methodology/approach

The methodology applied consists of panel estimators with fixed effects. In addition, a panel data model with instrumental variables is considered to tackle with potential problems of endogeneity in the model.

Findings

The results show there is a strong positive relationship between political risk and sovereign spread in Latin America, i.e., greater political risk is associated with greater sovereign spread. This effect is particularly significant when the political risk is associated with a weak rule of law or low-quality regulation in the country.

Research limitations/implications

The main limitation of this study concerns the potential risks of endogeneity which might exist between sovereign risk and political risk measures, which may not have been completely eliminated with the econometric methodology used.

Originality/value

This paper contributes to the literature of sovereign risk by studying the dimension of political risk in detail. Specifically, six dimensions of political risk are studied. Additionally, it provides empirical evidence, including the 2008 financial crisis period, regarding the determinants of spreads on Latin American economies.

Propósito

En este trabajo se estudia la relación existente entre 6 diferentes dimensiones de riesgo político de un país y su spread soberano para una muestra de 12 países latinoamericanos.

Diseño/metodología/enfoque

La metodología utilizada corresponde a estimadores de panel con efectos fijos. Además, se considera un modelo de panel con variable instrumental para lidiar con posibles problemas de endogeneidad en el modelo.

Recomendaciones

Los resultados muestran que existe una fuerte relación positiva entre riesgo político y spread soberanos en América Latina, es decir, mayor riesgo político está asociado a mayor spread soberano. Este efecto es particularmente significativo cuando el riesgo político está asociado a un Estado de Derecho débil o a una baja calidad regulatoria en el país.

limitaciones de la investigación

La principal limitación de este estudio son los potenciales riesgos de endogeneidad que pudieran existir entre las medidas de riesgo político y riesgo soberano, y que no hayan sido eliminadas completamente con la metodología econométrica utilizada.

La originalidad/valor

este trabajo contribuye a la literatura de riesgo soberano estudiando la dimensión de riesgo político en detalle. En particular, se consideran 6 posibles dimensiones del riesgo político. Además, provee evidencia empírica reciente, incluyendo el período de crisis financiera del 2008, respecto a los determinantes de spread en economías latinoamericanas.

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