Showing papers by "Horacio Sapriza published in 2009"

Financially Constrained Stock Returns

Abstract: We study the effect of financial constraints on risk and expected returns by extending the investment-based asset pricing framework to incorporate retained earnings, debt, costly equity, and collateral constraints on debt capacity. Quantitative results show that more financially constrained firms are riskier and earn higher expected stock returns than less financially constrained firms. Intuitively, by preventing firms from financing all desired investments, collateral constraints restrict the flexibility of firms in smoothing dividend streams in the face of aggregate shocks. The inflexibility mechanism also gives rise to a convex relation between market leverage and expected stock returns. A VOLUMINOUS LITERATURE in corporate finance and macroeconomics has studied in depth the impact of financial constraints on firm value, capital investment, and business cycles. 1 In asset pricing, an important open question is how financial constraints affect risk and expected returns. Using the Kaplan and Zingales (1997) index of financial constraints, Lamont, Polk, and Sa ´ a-Requejo (2001) report that more constrained firms earn lower average returns than less constrained firms. However, Whited and Wu (2006) use an alternative index and find that more constrained firms earn higher average returns than less constrained firms, although the difference is insignificant. Conflicting evidence is difficult to interpret without models that explicitly tie the characteristics in question with risk and expected returns. We aim to fill this gap. We study the effect of financial constraints on risk and expected stock returns by extending the neoclassical investment framework to incorporate retained earnings, debt, costly equity, and collateral constraints on debt capacity. In doing so, we fill an important void in the literature. To the best

Code and data files for "Fiscal Policy and Default Risk in Emerging Markets"

Abstract: All Matlab and C++ programs necessary to produce the results of the article. There is also a Excel spreadsheet with Mexican data.

Heterogeneous borrowers in quantitative models of sovereign default

Abstract: We extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to stochastically alternate in power. We show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions. Under high political stability, political turnover enables the model to generate a weaker correlation between economic conditions and default decisions, a higher and more volatile spread, and lower borrowing levels after a default episode.

Indexed Sovereign Debt: An Applied Framework

Abstract: A number of countries have issued sovereign debt instruments indexed to real variables in recent years. This type of contracts could improve risk sharing between debtor countries and international creditors and diminish the probability of occurrence of debt crises. This paper characterizes the optimal features of real indexed sovereign debt contracts in a dynamic stochastic equilibrium framework with incomplete markets. We show that the optimal indexed debt contract should not be studied abstracting from the total portfolio of assets and liabilities of the issuing country. We also show that the optimal contract is similar to an insurance contract, and that a country can replicate it using existing instruments, in particular, a combination of international reserves and GDP-indexed bonds. Calibrating our model to Argentina's economy we find that the welfare gains from introducing indexed debt and allowing asset accumulation could be equivalent to an increase of between 0.1% and 0.5% in certainty equivalent aggregate consumption.

Fiscal Policy and Default Risk in Emerging Markets

Abstract: Emerging market economies typically exhibit a procyclical fiscal policy: public expenditures rise (fall) in economic expansions (recessions), whereas tax rates rise (fall) in bad (good) times. Additionally, the business cycle of these economies is characterized by countercyclical default risk. In this paper we develop a quantitative dynamic stochastic small open economy model with incomplete markets, endogenous fiscal policy and sovereign default where public expenditures and tax rates are optimally procyclical. The model also accounts for the dynamics of other key macroeconomic variables in emerging economies.

On the cyclicality of the interest rate in emerging economy models: solution methods matter

Abstract: We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations such that the borrowing levels that are observed more frequently in the simulations feature a high sensitivity of the bond price to the borrowing level. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets. ; Replaces Working Paper 06-11 (Computing Business Cycles in Emerging Economy Models) ; Updated by Working Paper 10-04 (Quantitative Properties of Sovereign Default Models: Solution Methods Matter)

Fiscal policy and default risk in emerging markets

Abstract: Emerging economies usually experience procyclical public expenditures, tax rates and private consumption, countercyclical default risk, interest rate spreads and current account and higher volatility in consumption than in output. In this article we develop a dynamic stochastic equilibrium model of a small open economy with endogenous fiscal policy, endogenous default risk and country interest rate spreads in an incomplete credit markets framework that rationalizes these empirical findings.