Credit risk

About: Credit risk is a research topic. Over the lifetime, 18595 publications have been published within this topic receiving 382866 citations.

Sovereign Risk and Secondary Markets

Abstract: Conventional wisdom says that, in the absence of sufficient default penalties, sovereign risk constraints credit and lowers welfare We show that this conventional wisdom rests on one implicit assumption: that assets cannot be retraded in secondary markets Once this assumption is relaxed, there is always an equilibrium in which sovereign risk is stripped of its conventional effects In such an equilibrium, foreigners hold domestic debts and resell them to domestic residents before enforcement In the presence of (even arbitrarily small) default penalties, this equilibrium is shown to be unique As a result, sovereign risk neither constrains welfare nor lowers credit At most, it creates some additional trade in secondary markets The results presented here suggest a change in perspective regarding the origins of sovereign risk and its remedies To argue that sovereign risk constrains credit, one must show both the insufficiency of default penalties and the imperfect workings of secondary markets To relax credit constraints created by sovereign risk, one can either increase default penalties or improve the workings of secondary markets

Aggregate Risk and the Choice Between Cash and Lines of Credit

Abstract: We model corporate liquidity policy and show that aggregate risk exposure is a key determinant of how firms choose between cash and bank credit lines. Banks create liquidity for firms by pooling their idiosyncratic risks. As a result, firms with high aggregate risk find it costly to get credit lines and opt for cash in spite of higher opportunity costs and liquidity premium. Likewise, in times when aggregate risk is high, firms rely more on cash than on credit lines. We verify these predictions empirically. Cross-sectional analyses show that firms with high exposure to systematic risk have a higher ratio of cash to credit lines and face higher spreads on their lines. Time-series analyses show that firms' cash reserves rise in times of high aggregate volatility and in such times credit lines initiations fall, their spreads widen, and maturities shorten. Also consistent with the mechanism in the model, we find that exposure to undrawn credit lines increases bank-specific risks in times of high aggregate volatility.

Euro Area Sovereign Risk During the Crisis

Abstract: While the use of public resources is critical to cushion the impact of the financial crisis on the euro-area economy, it is key that the entailed fiscal costs not be seen by markets as undermining fiscal sustainability From this perspective, to what extent do movements in euro area sovereign spreads reflect country-specific solvency concerns? In line with previous studies, the paper suggests that euro area sovereign risk premium differentials tend to comove over time and are mainly driven by a common time-varying factor, mimicking global risk repricing Since October 2008, however, there is evidence that markets have become progressively more concerned about the potential fiscal implications of national financial sectors' frailty and future debt dynamics The liquidity of sovereign bond markets still seems to play a significant (albeit fairly limited) role in explaining changes in euro area spreads

International Reserve Holdings with Sovereign Risk and Costly Tax Collection

Abstract: We derive a precautionary demand for international reserves in the presence of sovereign risk and show that political-economy considerations modify the optimal level of reserve holdings. A greater chance of opportunistic behaviour by future policy makers and political corruption reduce the demand for international reserves and increase external borrowing. We provide evidence to support these findings. Consequently, the debt-to-reserves ratio may be less useful as a vulnerability indicator. A version of the Lucas Critique suggests that if a high debt-to-reserves ratio is a symptom of opportunistic behaviour, a policy recommendation to increase international reserve holdings may be welfare-reducing.

Implications of credit constraints for risk behaviour in less developed economies

Abstract: DOES the capacity to absorb risk stem only from something innate-a psychological trait or preference structure? The purpose of this paper is to suggest that the ability to smooth out consumption over time, with one's own wealth or through access to consumption credit, may be an important determinant of risk-bearing capacity. We show that if individuals have identical risk preferences, those with access to greater amounts of consumption credit will have greater capacity to absorb risk. The above result does not have implications of much significance in economies characterized by capital markets so well developed that all individuals have access to adequate amounts of consumption credit. The same thing can be said of economies which have reached a level of affluence (and hence a level of individual savings) that makes borrowing for consumption purposes unnecessary. But the result does acquire significance in many less developed countries where the accumulated savings of the poorer segments of the society are entirely inadequate to prevent significant downswings in consumption in the bad states of nature. Moreover, the distribution of access to credit in less developed countries is notoriously skewed across the population. We assume that individuals are risk-averse. In the particular characterization of risk preferences which is appropriate to the intertemporal context, risk-averse individuals prefer a smooth consumption profile over time to an uneven one. An agent who is either wealthy or has considerable access to credit can disengage each period's consumption from the income realized in that period: when the income draw is poor he can either dissave or borrow, and when the draw is good he can either replenish his wealth or repay the debt. The capacity to bear risk, in this view, is derived from the ability to stabilize consumption over time. Put differently, the cost of risk to an individual can be reduced if he could pool risks over time. Wealth or access to capital enables him to do precisely this. Thus, even when all agents have identical risk preferences, differential risk behaviour would still obtain if the agents have differential access to capital. This paper formalizes the above idea. Two key features of our view are: (a) the essentially intertemporal nature of risk-bearing, and (b) the peculiarity of captial markets as manifest in differential access to credit across agents. The intertemporal nature of risk-bearing is eminently reasonable since, in reality, the effects of even a one-period gamble are spread out across several periods. Moreover, many important decisions under uncertainty entail sequences of gambles rather