Credit Cycle Dependent Spread Determinants in Emerging Sovereign Debt Markets

32 Pages Posted: 19 Mar 2013

See all articles by Christoph Riedel

Christoph Riedel

University of Passau

Kannan S. Thuraisamy

Deakin University - Faculty of Business and Law

Niklas Wagner

Passau University

Date Written: March 18, 2013

Abstract

We address credit cycle dependent sovereign credit risk determinants. In our model, the spread determinants' magnitude is conditional on an unobservable endogenous sovereign credit cycle as represented by the underlying state of a Markov regime switching process. Our explanatory variables are motivated in the tradition of structural credit risk models and include changes in asset prices, interest rates, implied market volatility, gold price changes and foreign exchange rates. We examine daily frequency variations of U.S. dollar denominated Eurobond credit spreads of four major Latin American sovereign bond issuers (Brazil, Colombia, Mexico and Venezuela) with liquid bond markets during March 2000 to June 2011. We find that spread determinants are statistically significant and consistent with theory, while their magnitude remarkably varies with the state of the credit cycle. Crisis states are characterized by high spread change uncertainty and high sensitivities with respect to the spread change determinants. We further document that not only changes of local currencies, but also changes of the Euro with respect to the U.S. dollar are significant spread drivers and argue that this is consistent with the sovereigns' ability to pay.

Keywords: sovereign bonds, sovereign spreads, sovereign credit cycle, structural models of credit risk, Eurobonds, regime switching, sovereign debt crises

JEL Classification: G15, G12

Suggested Citation

Riedel, Christoph and Thuraisamy, Kannan S. and Wagner, Niklas F., Credit Cycle Dependent Spread Determinants in Emerging Sovereign Debt Markets (March 18, 2013). Emerging Markets Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2235144 or http://dx.doi.org/10.2139/ssrn.2235144

Christoph Riedel

University of Passau ( email )

Innstrasse 29
Passau, 94032
Germany

Kannan S. Thuraisamy

Deakin University - Faculty of Business and Law ( email )

Burwood, Victoria 3215
Australia

Niklas F. Wagner (Contact Author)

Passau University ( email )

Innstrasse 27
Passau, 94030
Germany

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