IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

A model of asset pricing under country risk

Listed author(s):
  • Andrade, Sandro C.
Registered author(s):

    I develop a formal model that could provide quantitative guidance to practitioners who use sovereign yield spreads in emerging market asset valuation. The model provides analytical formulas relating emerging market stock P/E ratios (and expected returns) to the corresponding average yield spread in sovereign bonds. In the model, sovereign yield spreads carry information about the likelihood of a negative regime change in an emerging market ("country risk"), under the common assumption that the regime change is associated with a hostile renegotiation of the country's foreign debt. In the model, country risk is priced because the regime change may be endogenously associated with bad states of the global economy. Data from emerging markets are consistent with some of the model's quantitative and qualitative predictions.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.sciencedirect.com/science/article/pii/S0261-5606(09)00011-4
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

    Article provided by Elsevier in its journal Journal of International Money and Finance.

    Volume (Year): 28 (2009)
    Issue (Month): 4 (June)
    Pages: 671-695

    as
    in new window

    Handle: RePEc:eee:jimfin:v:28:y:2009:i:4:p:671-695
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30443

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as
    in new window


    1. Eaton, Jonathan & Fernandez, Raquel, 1995. "Sovereign debt," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077 Elsevier.
    2. Geert Bekaert & Campbell R. Harvey, 1997. "Foreign Speculators and Emerging Equity Markets," William Davidson Institute Working Papers Series 79, William Davidson Institute at the University of Michigan.
    3. Galai, Dan & Masulis, Ronald W., 1976. "The option pricing model and the risk factor of stock," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 53-81.
    4. Michael J. Brennan & Ashley W. Wang & Yihong Xia, 2004. "Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing," Journal of Finance, American Finance Association, vol. 59(4), pages 1743-1776, 08.
    5. Carrieri, Francesca & Errunza, Vihang & Majerbi, Basma, 2006. "Does Emerging Market Exchange Risk Affect Global Equity Prices?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(03), pages 511-540, September.
    6. Domowitz, Ian & Glen, Jack & Madhavan, Ananth, 1997. " Market Segmentation and Stock Prices: Evidence from an Emerging Market," Journal of Finance, American Finance Association, vol. 52(3), pages 1059-1085, July.
    7. Bonomo, Marco Antônio Cesar & Garcia, René, 1999. "Tests of conditional asset pricing models in the brazilian stock market," Economics Working Papers (Ensaios Economicos da EPGE) 350, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
    8. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
    9. Kulatilaka, Nalin & Marcus, Alan J., 1987. "A model of strategic default of sovereign debt," Journal of Economic Dynamics and Control, Elsevier, vol. 11(4), pages 483-498, December.
    10. Errunza, Vihang & Losq, Etienne, 1985. " International Asset Pricing under Mild Segmentation: Theory and Test," Journal of Finance, American Finance Association, vol. 40(1), pages 105-124, March.
    11. Bakshi, Gurdip & Chen, Zhiwu, 2005. "Stock valuation in dynamic economies," Journal of Financial Markets, Elsevier, vol. 8(2), pages 111-151, May.
    12. Daniel Cohen & Jeffrey Sachs, 1991. "Growth and External Debt Under Risk of Debt Repudiation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 437-472 National Bureau of Economic Research, Inc.
    13. Campbell R. Harvey, 1994. "Predictable Risk and Returns in Emerging Markets," NBER Working Papers 4621, National Bureau of Economic Research, Inc.
    14. Francis E. Warnock & Hali J Edison, 2001. "A Simple Measure of the Intensity of Capital Controls," IMF Working Papers 01/180, International Monetary Fund.
    15. Phylaktis, Kate & Ravazzolo, Fabiola, 2002. "Measuring financial and economic integration with equity prices in emerging markets," Journal of International Money and Finance, Elsevier, vol. 21(6), pages 879-903, November.
    16. Goetzmann, William N. & Jorion, Philippe, 1999. "Re-Emerging Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(01), pages 1-32, March.
    17. Claessens, Stijn & Pennacchi, George, 1996. "Estimating the Likelihood of Mexican Default from the Market Prices of Brady Bonds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(01), pages 109-126, March.
    18. Hui Chen, 2010. "Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure," NBER Working Papers 16151, National Bureau of Economic Research, Inc.
    19. Albuquerque, Rui & Wang, Neng, 2005. "Agency Conflicts, Investment and Asset Pricing," CEPR Discussion Papers 4955, C.E.P.R. Discussion Papers.
    20. 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.
    21. Jonathan Berk & Richard C. Green & Vasant Naik, "undated". "Optimal Investment, Growth Options and Security Returns," GSIA Working Papers 64, Carnegie Mellon University, Tepper School of Business.
    22. Hayne E. Leland., 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Research Program in Finance Working Papers RPF-233, University of California at Berkeley.
    23. Anusha Chari & Peter Blair Henry, 2002. "Risk Sharing and Asset Prices: Evidence From a Natural Experiment," NBER Working Papers 8988, National Bureau of Economic Research, Inc.
    24. Leuz, Christian & Nanda, Dhananjay & Wysocki, Peter D., 2003. "Earnings management and investor protection: an international comparison," Journal of Financial Economics, Elsevier, vol. 69(3), pages 505-527, September.
    25. Bekaert, Geert & Harvey, Campbell R., 1997. "Emerging equity market volatility," Journal of Financial Economics, Elsevier, vol. 43(1), pages 29-77, January.
    26. 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.
    27. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign "CDS" Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
    28. Hayne E. Leland, 1998. "Agency Costs, Risk Management, and Capital Structure," Journal of Finance, American Finance Association, vol. 53(4), pages 1213-1243, 08.
    29. Andrew K. Rose, 2002. "One Reason Countries Pay their Debts: Renegotiation and International Trade," NBER Working Papers 8853, National Bureau of Economic Research, Inc.
    30. Bekaert, Geert & Harvey, Campbell R., 2002. "Research in emerging markets finance: looking to the future," Emerging Markets Review, Elsevier, vol. 3(4), pages 429-448, December.
    31. Nishiotis, George P., 2004. "Do Indirect Investment Barriers Contribute to Capital Market Segmentation?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(03), pages 613-630, September.
    32. Bekaert, Geert, 1995. "Market Integration and Investment Barriers in Emerging Equity Markets," World Bank Economic Review, World Bank Group, vol. 9(1), pages 75-107, January.
    33. Harjoat S. Bhamra & Lars-Alexander Kuehn & Ilya A. Strebulaev, 2010. "The Levered Equity Risk Premium and Credit Spreads: A Unified Framework," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 645-703, February.
    34. Bailey, Warren & Chung, Y. Peter & Kang, Jun-koo, 1999. "Foreign Ownership Restrictions and Equity Price Premiums: What Drives the Demand for Cross-Border Investments?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 34(04), pages 489-511, December.
    35. Geert Bekaert & Campbell R. Harvey & Christian T. Lundblad & Stephan Siegel, 2010. "What Segments Equity Markets?," National Bank of Poland Working Papers 76, National Bank of Poland, Economic Institute.
    36. Bailey, Warren & Jagtiani, Julapa, 1994. "Foreign ownership restrictions and stock prices in the Thai capital market," Journal of Financial Economics, Elsevier, vol. 36(1), pages 57-87, August.
    37. Tom Keck & Eric Levengood & AL Longfield, 1998. "Using Discounted Cash Flow Analysis In An International Setting: A Survey Of Issues In Modeling The Cost Of Capital," Journal of Applied Corporate Finance, Morgan Stanley, vol. 11(3), pages 82-99.
    38. Cherian, Joseph A & Perotti, Enrico C, 1999. "Option Pricing and Foreign Investment under Political Risk," CEPR Discussion Papers 2327, C.E.P.R. Discussion Papers.
    39. Peter Blair Henry, 2000. "Stock Market Liberalization, Economic Reform, and Emerging Market Equity Prices," Journal of Finance, American Finance Association, vol. 55(2), pages 529-564, 04.
    40. Mark Aguiar & Gita Gopinath, 2004. "Defaultable Debt, Interest Rates and the Current Account," NBER Working Papers 10731, National Bureau of Economic Research, Inc.
    41. Bekaert, Geert & Harvey, Campbell R., 2003. "Emerging markets finance," Journal of Empirical Finance, Elsevier, vol. 10(1-2), pages 3-56, February.
    42. Bailey, Warren & Chung, Y. Peter, 1995. "Exchange Rate Fluctuations, Political Risk, and Stock Returns: Some Evidence from an Emerging Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(04), pages 541-561, December.
    43. Errunza, Vihang R. & Miller, Darius P., 2000. "Market Segmentation and the Cost of the Capital in International Equity Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(04), pages 577-600, December.
    44. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1987. "International real business cycles," Working Papers 426, Federal Reserve Bank of Minneapolis.
    45. Longstaff, Francis A. & Piazzesi, Monika, 2004. "Corporate earnings and the equity premium," Journal of Financial Economics, Elsevier, vol. 74(3), pages 401-421, December.
    46. Kristin Forbes & Roberto Rigobon, 1999. "No Contagion, Only Interdependence: Measuring Stock Market Co-movements," NBER Working Papers 7267, National Bureau of Economic Research, Inc.
    47. Federico Sturzenegger & Jeromin Zettelmeyer, 2007. "Creditors' Losses Versus Debt Relief: Results from a Decade of Sovereign Debt Crises," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 343-351, 04-05.
    48. Geert Bekaert & Campbell R. Harvey & Christian Lundblad & Stephan Siegel, 2004. "Global Growth Opportunities and Market Integration," NBER Working Papers 10990, National Bureau of Economic Research, Inc.
    49. Hayri, A., 1996. "Debt Relief," The Warwick Economics Research Paper Series (TWERPS) 459, University of Warwick, Department of Economics.
    50. Rene M. Stulz, 2005. "The Limits of Financial Globalization," NBER Working Papers 11070, National Bureau of Economic Research, Inc.
    51. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
    52. Rodolfo Martell & René M. Stulz, 2003. "Equity-Market Liberalizations as Country IPO's," American Economic Review, American Economic Association, vol. 93(2), pages 97-101, May.
    53. 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.
    54. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
    55. Javier Estrada, 2007. "Discount Rates in Emerging Markets: Four Models and An Application," Journal of Applied Corporate Finance, Morgan Stanley, vol. 19(2), pages 72-77.
    56. Carrieri, Francesca & Errunza, Vihang & Hogan, Ked, 2007. "Characterizing World Market Integration through Time," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(04), pages 915-940, December.
    57. Stulz, Rene M, 1981. "On the Effects of Barriers to International Investment," Journal of Finance, American Finance Association, vol. 36(4), pages 923-934, September.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:eee:jimfin:v:28:y:2009:i:4:p:671-695. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.