Credit risk

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

Accounting-Based Versus Market-Based Cross-Sectional Models of CDS Spreads

Abstract: The relevance of accounting data to providers of capital has been strongly debated. In this paper we provide compelling evidence that accounting metrics are important to providers of debt capital. Models of firm distress are mostly either purely accounting-based (e.g. Altman, 1968; Ohlson, 1980) or purely market-based (e.g. Merton, 1974). We examine the information content of accounting-based and market-based metrics in pricing firm distress using a sample of Credit Default Swap (CDS) spreads. Credit Default Swaps are derivatives that offer protection from the event a given firm defaults on its obligations. CDS spreads provide a clean measure of default risk as they are the compensation that market participants require for bearing that risk. Using a sample of 2,860 quarterly CDS spreads available over the period 2001-2005 we find that a model of distress which is entirely composed of accounting-based metrics performs comparably, if not better, than market-based structural models of default. Furthermore, we find that both sources of information (accounting- and market-based) are complementary in pricing distress. These results support the notion that accounting metrics have direct value- or valuation-relevance to debt holders and holders of credit derivatives.

Empirical Determinants of Emerging Market Economies' Sovereign Bond Spreads

Abstract: This paper investigates the empirical determinants of emerging market sovereign bond spreads, using a ragged-edge panel of JP Morgan EMBI and EMBI Global secondary market spreads and a set of common macro-prudential indicators. The panel is estimated using the pooled mean group technique due to Pesaran, Shin and Smith (1999). This is essentially a dynamic error correction model where cross-sectional coefficients are allowed to vary in the short run but are required to be homogeneous in the long run. This allows a separation of short-run dynamics and adjustment towards the equilibrium. The model is used to benchmark market spreads and assess whether sovereign risk was 'overpriced' or 'underpriced' during different periods over the past decade. The results suggest that a debtor country's fundamentals and external liquidity conditions are important determinants of market spreads. However, the diagnostic statistics also indicate that the market assessment of a country's creditworthiness is more broad based than that provided by the set of fundamentals included in the model. We also find that the generalised fall in sovereign spreads seen between 1995 and 1997 cannot be entirely explained in terms of improved fundamentals.

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-toreserves ratio is a symptom of opportunistic behaviour, a policy recommendation to increase international reserve holdings may be welfare-reducing. Over the past fifteen years, developing countries have increased their participation in international financial markets and faced new challenges. In the aftermath of the 1997‐8 Asian financial crises, some observers have called on emerging markets to reduce short-term external debt relative to international reserve holdings in order to lower their vulnerability to crisis. Countries such as Korea, Taiwan and Chile have managed to build up large stockpiles of foreign-currency reserves in recent years. Does it follow that all developing countries would benefit from increasing their cushion of international reserves to signal they are safe borrowers? As the Lucas Critique suggests, this question cannot be answered without understanding the underlying factors that determine a country’s choice of international reserve holdings. We illustrate this point using a model where both efficiency and politicaleconomy considerations play roles in determining a country’s optimal holdings of international reserves. In the absence of political-economy considerations, a country characterised by volatile output, inelastic demand for fiscal outlays, high tax collection costs and sovereign risk will want to accumulate both international reserves and external debt. External debt allows the country to smooth consumption when output is volatile. International reserves, if they are beyond the reach of creditors, allow the country to smooth consumption in the event of a default on the external debt that results in lost access to international capital markets. 1

Corporate Environmental Management and Credit Risk

Abstract: This study analyzes environmental management and its implications for bond investors. Poor environmental practices influence the credit standing of borrowing firms through the legal, reputational, and regulatory risks associated with environmental incidents. We devise environmental performance measures based on information from an independent rating agency, and provide evidence that these measures explain the cross-sectional variation in credit risk for a sample of 582 U.S. public corporations between 1995 and 2006. Our findings suggest that firms with environmental concerns pay a premium on their cost of debt financing and are assigned lower credit ratings. In contrast, firms with proactive environmental engagement benefit from a lower cost of debt financing. The results are robust to numerous controls for company and bond specific characteristics, alternative model specifications, and industry membership.