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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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Related research

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. Jeremy I. Bulow & Kenneth Rogoff, 1987. "A Constant Recontracting Model of Sovereign Debt," NBER Working Papers 2088, National Bureau of Economic Research, Inc.
  2. Bennett Sutton & Luis Catão, 2002. "Sovereign Defaults," IMF Working Papers 02/149, International Monetary Fund.
  3. 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.
  4. Andre Santos & Jorge A. Chan-Lau, 2006. "Currency Mismatches and Corporate Default Risk," IMF Working Papers 06/269, International Monetary Fund.
  5. Bulow, Jeremy & Rogoff, Kenneth S., 1989. "A Constant Recontracting Model of Sovereign Debt," Scholarly Articles 12491028, Harvard University Department of Economics.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  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. 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.
  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. 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.
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Cited by:
  1. Martin Brown & Ralph De Haas & Vladimir Sokolov, 2013. "Regional inflation and financial dollarisation," Working Papers 163, European Bank for Reconstruction and Development, Office of the Chief Economist.

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