Sovereign Debt Distress and Corporate Spillover Impacts
In much of the standard corporate finance literature in which sovereign debt is treated as a risk free asset, corporate bond prices are seen to depend on idiosyncratic risk factors specific to the issuing company, with public debt playing an indire...
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| Language: | English |
| Published: |
2012
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| Online Access: | http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20100726102657 http://hdl.handle.net/10986/3864 |
| Summary: | In much of the standard corporate
finance literature in which sovereign debt is treated as a
risk free asset, corporate bond prices are seen to depend on
idiosyncratic risk factors specific to the issuing company,
with public debt playing an indirect role to the extent that
it affects the term structure of interest rates. In the
corporate world, however, the ability of a borrower to
access international capital markets and the terms according
to which it can raise capital depend not only on its own
creditworthiness, but also on the financial health of its
home-country sovereign. In times of financial stress, when
investors lose confidence in the government's ability
to use public finances to stabilize the economy or provide a
safety net for corporations in distress, markets'
assessment of private credit risk takes on a completely
different dynamic than during normal times, incorporating an
additional risk premium to compensate investors for the
potential consequences of sovereign default. Using a new
database that covers nearly every emerging-market corporate
and sovereign entity that has issued bonds on global markets
between 1995 and 2009, this paper investigates the degree to
which heightened sovereign default risk perceptions during
times of market turmoil influence the determination of
corporate bond yield spreads, controlling for specific bond
attributes and common global risk factors. Econometric
evidence presented confirms that investors' perceptions
of sovereign debt problems translate into higher costs of
capital for private corporate issuers, with the magnitude of
such costs increasing at times when sovereign bonds trade at
spreads exceeding a threshold of 1000 bps. The key policy
recommendation emerging from the analysis relates to the
need to improve sovereign creditworthiness in order to
prevent a loss in investor confidence that could trigger a
panicky sell-off in sovereign debt with adverse
macroeconomic and fiscal consequences. Implications for
future research point to the need to develop better models
of corporate bond pricing and valuation, recognizing
explicitly the role of sovereign credit risk. |
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