Determinants of Spreads on Sovereign Bank Loans: The Role of Credit History

Abstract

This paper is an empirical investigation into the role of credit history in determining the spread on sovereign bank loans. It employs an error-in-variables approach used in rationalexpectations-macro-econometrics to set up a structural model that links sovereign loan spreads to realized repayment behavior. Unlike the existing empirical literature, its instrumental variables method allows for distinguishing a direct influence of past repayment problems (a "pure reputation" effect) from one that goes through increased default probabilities. Using developing country data from the period 1973-1981 and constructing continuous variables for credit history, we find that past default is a significant determinant of the spread, even after including country fixed effects. Moreover, its reduced-form effect is very similar to its structural form effect, indicating that most of the influence of past repayment problems is through the reputation channel. Overall, reserves to imports, past and predicted future default are substantial determinants of sovereign bank loan spreads. JEL Classification Numbers: F30, F34, G12, G14, G15

The Economics and Law of Sovereign Debt and Default

“…This said, the precision and, hence, statistical significance of Özler's (1993) results may be overstated because the regression is based on loan-level data without clustering of standard errors. Indeed, in a paper examining borrowing costs during the same period using country-level data and a different methodology, Péter Benczúr and Cosmin Ilut (2006) do not find a statistically significant effect of distant (pre-1970s) default history on spreads, although they do find an effect of recent default history.…”

Fund Managers, Career Concerns, and Asset Price Volatility

“…Finally, our model can be naturally interpreted as a model of sovereign debt. In this sense is related to the vast literature on …nancial crisis in emerging economies and reversal of capital ‡ows, including Atkenson (1991), Cole and Kehoe (2000), Calvo and Mendoza (2000), Caballero and Krishnamurthy (2003), Benczur and Ilut (2005), Aguiar and Gopinath (2006), Uribe and Yue (2006), and Kovrijnykh and Szentes (2007), Arellano (2008). This strand of literature abstracts from the e¤ects of intermediation in …nancial markets, and could be interestingly complemented with our mechanism.…”

“…Our paper is also related to a large literature on the propagation and ampli…cation of fundamental shocks due to the interaction between asset values and collateralized lending. Seminal papers in this area are Bernanke and Gertler (1989) and Kiyotaki and Moore (1997) on the macro-side, and Gromb and Vayanos (2002) on the …nance side 1 . The main di¤erence with our mechanism is that these papers have typically an asymmetric distortion, given that collateral constraints build into the model an external …nance premium, usually generating underinvestment.…”

Fund Managers and Defaultable Debt

“…Hence, the equilibrium price of 3 See also Aghion, Banerjee and Piketty (1999), Rampini (2003), Krishnamurthy (2003), Gai, Kondor and Vause (2005), Guerrieri and Lorenzoni (2007) on the macro side and Danielsson, Shin and Zigrand (2004), Morris and Shin (2004), Bernardo and Welch (2004) and Kondor (2007a) on the …nance side. 4 Atkenson (1991), Cole and Kehoe (2000), Aguiar and Gopinath (2006), Caballero and Krishnamurthy (2003), Calvo and Mendoza (2000), Benczur and Ilut (2005), Arellano (2006), Uribe and Yue (2006), Kovrijnykh and Szentes (2007). the risky bond has to satisfy the following indi¤erence condition…”

“…to die, in which case a new manager of the same type is born. 7 Finally, all investors who do not have a manager, either because they have …red him or because he is dead, randomly search for a new one. At the same time, the unemployed managers decide whether to pay a cost to search for a job.…”