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Capital Flows, Sovereign Debt, and Risk

Paper Session

Sunday, Jan. 5, 2020 1:00 PM - 3:00 PM (PST)

Marriott Marquis, Grand Ballroom 10
Hosted By: American Economic Association
  • Chair: Sergio Schmukler, World Bank

In Search of Distress Risk in Emerging Markets

Gonzalo Asis
,
University of North Carolina-Chapel Hill
Anusha Chari
,
University of North Carolina-Chapel Hill and NBER
Adam Haas
,
University of North Carolina-Chapel Hill

Abstract

Although the non-financial corporate sector accounts for the lion’s share of the post-Global Financial Crisis surge in emerging-market leverage, there is little systematic research on the factors that impact corporate distress risk in emerging markets. Existing bankruptcy risk models developed using US data have low predictive power when applied to emerging market firms. We suggest that these models do not account for emerging market vulnerabilities to global shocks such as advanced economy monetary policy changes, US dollar movements, or shifts in global liquidity and risk-aversion. A novel multi-country dataset of corporate defaults allows us to quantify the importance of global shocks on emerging market corporate distress. Using a set of accounting, market, and macroeconomic variables, we develop a model of distress risk specific to emerging markets with comparable forecasting power to that of existing models based on US data. We also explore the asset pricing implications of our model by testing whether equity returns accurately reflect default risk. We find that global factors like US interest rates and credit risk contribute more predictive power for corporate default risk than domestic macroeconomic variables, especially for those firms whose stock returns are most sensitive to global financial conditions.

Corporate Bond Spreads, Sovereign Spreads, and Crises

Julia Bevilaqua
,
Federal Reserve Bank of San Francisco
Galina Hale
,
Federal Reserve Bank of San Francisco
Eric Tallman
,
Federal Reserve Bank of San Francisco

Abstract

We document a new stylized fact that correlation between sovereign and corporate spreads breaks down during sovereign debt crises (i.e., when sovereign spreads are high). This finding is at odds with conventional wisdom that bond ratings are subject to a sovereign ceiling and therefore bond yields are subject to sovereign “floors.” We find that during sovereign debt crises foreign investors are willing to purchase corporate debt at lower rates than they charge the sovereign. This fact is not explained by the composition of bond issuers and is observed for borrowers from both advanced and emerging economies. We propose a simple model in which we take sovereign spreads and sovereign debt crisis events as exogenous and analyze global investors’ response in terms of corporate debt pricings.

The Financial Center Leverage Cycle: Does it Spread Around the World?

Graciela Laura Kaminsky
,
George Washington University and NBER
Leandro Medina
,
International Monetary Fund
Shiyi Wang
,
George Washington University

Abstract

With a novel database, we examine the evolution of capital flows since the collapse of the Bretton Woods System in the early 1970s. We decompose capital flows into global, regional, and idiosyncratic factors. In contrast to previous findings, which mostly use data from the 2000s, we find that booms and busts in capital flows are mainly explained by regional factors and not the global factor. We link leverage in the financial center to regional capital flows and the cost of borrowing in international capital markets to examine the drivers of capital flow bonanzas and busts.

Winners and Losers from Sovereign Debt Inflows: Evidence from the Stock Market

Lorenzo Pandolfi
,
University of Naples Federico II and CSEF
Tomas Williams
,
George Washington University

Abstract

This paper analyzes the effects on firms of capital inflows to the sovereign debt markets of emerging countries. To deal with the endogeneity between capital inflows and economic activity, we focus on capital inflows driven by countries’ inclusions into well-known local currency sovereign debt market indexes. These events convey little information about the future economic prospects of countries but induce large capital flows from institutional investors tracking the indexes. We show that inclusion-driven flows significantly reduce government bond yields and appreciate the domestic currency. In turn, these changes have heterogenous impact on firms’ stock market returns. Government related firms, financial firms and firms with larger financial constraints experience positive abnormal returns in the two days following the announcement of these events. Instead, companies operating in export-intensive sectors have negative abnormal returns. Our findings shed novel light on the channels through which capital inflows to sovereign debt markets affect firms in the economy.
JEL Classifications
  • F3 - International Finance
  • F6 - Economic Impacts of Globalization