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Credit Risk Spreads in Local and Foreign Currencies

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  • DAN GALAI
  • ZVI WIENER

Abstract

The paper shows how-in a Merton-type model with bankruptcy-the currency composition of debt changes the risk profile of a company raising a given amount of financing, and thus affects the cost of debt. Foreign currency borrowing is cheaper when the exchange rate is positively correlated with the return on the company''s assets, even if the company is not an exporter. Prudential regulations should therefore differentiate among loans depending on the extent to which borrowers have "natural hedges" of their foreign currency exposures.

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File URL: http://hdl.handle.net/10.1111/j.1538-4616.2012.00514.x
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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 44 (2012)
Issue (Month): 5 (08)
Pages: 883-901

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Handle: RePEc:mcb:jmoncb:v:44:y:2012:i:5:p:883-901

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
  2. Bulow, Jeremy & Rogoff, Kenneth, 1989. "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, University of Chicago Press, vol. 97(1), pages 155-78, February.
  3. Francis A. Longstaff & Jun Pan & Lasse H. Pedersen & Kenneth J. Singleton, 2011. "How Sovereign Is Sovereign Credit Risk?," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 75-103, April.
  4. Diaz Weigel, Diana & Gemmill, Gordon, 2006. "What drives credit risk in emerging markets? The roles of country fundamentals and market co-movements," Journal of International Money and Finance, Elsevier, vol. 25(3), pages 476-502, April.
  5. Jens Hilscher & Yves Nosbusch, 2007. "Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt," Money Macro and Finance (MMF) Research Group Conference 2006 114, Money Macro and Finance Research Group, revised 24 Apr 2007.
  6. Darrell Duffie & Lasse Heje Pedersen & Kenneth J. Singleton, 2003. "Modeling Sovereign Yield Spreads: A Case Study of Russian Debt," Journal of Finance, American Finance Association, vol. 58(1), pages 119-159, 02.
  7. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  8. Andre Santos & Jorge A. Chan-Lau, 2006. "Currency Mismatches and Corporate Default Risk," IMF Working Papers 06/269, International Monetary Fund.
  9. Merton, Robert C., 1977. "On the pricing of contingent claims and the Modigliani-Miller theorem," Journal of Financial Economics, Elsevier, vol. 5(2), pages 241-249, November.
  10. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  11. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  12. Jorion, Philippe, 1990. "The Exchange-Rate Exposure of U.S. Multinationals," The Journal of Business, University of Chicago Press, vol. 63(3), pages 331-45, July.
  13. Bennett Sutton & Luis Catão, 2002. "Sovereign Defaults," IMF Working Papers 02/149, International Monetary Fund.
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Cited by:
  1. Brown, Martin & De Haas, Ralph & Sokolov, Vladimir, . "Regional Inflation and Financial Dollarization," Working Papers on Finance 1327, University of St. Gallen, School of Finance.
  2. Brown, M. & Haas, R. de & Sokolov, V., 2013. "Regional Inflation and Financial Dollarization," Discussion Paper 2013-073, Tilburg University, Center for Economic Research.

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