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Credit Risk Spreads in Local and Foreign Currencies

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Author Info

  • Zvi Wiener
  • Dan Galai

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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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 09/110.

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Length: 20
Date of creation: 01 May 2009
Date of revision:
Handle: RePEc:imf:imfwpa:09/110

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Keywords: Dollarization; Bonds; Corporate sector; Credit risk; Debt restructuring; Economic models; Exchange rates; Sovereign debt; correlation; bond; present value; probability; correlations; currency mismatch; equation; hedge; standard deviation; hedging; corporate bond; hedges; financial markets; currency risk; denominated bond; bond offerings; international financial markets; risk-free interest rate; rate of change; nominal exchange rate; horizontal axis; denominated bonds; probability distribution; bond valuation; financial institutions; default-free bond; probability function; financial derivatives; statistical distribution; stock returns; financial structure; statistical correlation; bond spread; bondholders;

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References

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  1. 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.
  2. Bennett Sutton & Luis Catão, 2002. "Sovereign Defaults," IMF Working Papers 02/149, International Monetary Fund.
  3. 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.
  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. 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.
  6. 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.
  7. Jens Hilscher & Yves Nosbusch, 2010. "Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt," Review of Finance, European Finance Association, vol. 14(2), pages 235-262.
  8. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  9. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  10. Andre Santos & Jorge A. Chan-Lau, 2006. "Currency Mismatches and Corporate Default Risk," IMF Working Papers 06/269, International Monetary Fund.
  11. 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.
  12. 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.
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Cited by:
  1. Brown, M. & Haas, R. de & Sokolov, V., 2013. "Regional Inflation and Financial Dollarization," Discussion Paper 2013-073, Tilburg University, Center for Economic Research.
  2. Brown, Martin & De Haas, Ralph & Sokolov, Vladimir, . "Regional Inflation and Financial Dollarization," Working Papers on Finance 1327, University of St. Gallen, School of Finance.

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