Emerging Markets and Sovereign Risk

317 Pages·2014·0.97 MB·English

by  Nigel Finch

Emerging Markets and
Sovereign Risk
Nigel Finch
Emerging Markets and Sovereign Risk
Also by Nigel Finch
BEST PRACTICES IN MANAGEMENT ACCOUNTING ( with G. N. Gregoriou )
CONTEMPORARY ISSUES IN MINING: LEADING PRACTICE IN AUSTRALIA
FUNDAMENTALS OF CORPORATE FINANCE ( with J. Berk, P. DeMarzo, J. Harford,
and G. Ford )
Emerging Markets and
Sovereign Risk
Edited by
Nigel Finch
Associate Professor, The University of Sydney, Australia
Editorial matter and selection © Nigel Finch 2015
All remaining chapters © respective authors 2015
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in accordance with the Copyright, Designs and Patents Act 1988.
First published 2015 by
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Contents
List of Figures v ii
List of Tables v iii
Acknowledgements x
Notes on Contributors xi
Part I Risk and Emerging Market Investment
1 Economic Growth vs. Equity Returns in Emerging Markets 3
R. McFall Lamm, Jr.
2 Default Risk of Sovereign Debt in Central America 1 8
Astrid Ayala, Szabolcs Blazsek, and Raúl B. González de Paz
3 Contagion in Emerging Markets 45
Serge Darolles, Jérémy Dudek, and Gaëlle Le Fol
4 Aspects of Volatility and Correlations in European Emerging
Economies 59
Anna Golab, David E. Allen, and Robert Powell
5 The Political Risk of Offshore Financial Centres:
The Cyprus Bail-Out 81
David Chaikin
Part II Rating Agencies and the Sovereign
Rating Process
6 Travels in the Ratings Space: Developed and Developing
Countries’ Sovereign Ratings 109
Lúcio Vinhas de Souza
7 The Sovereign Rating Regulatory Dilemma 1 18
Jeffrey Manns
8 A Framework for Understanding the Acceptability of
Rating Agency Methodologies 153
Nigel Finch
v
vi Contents
9 Sovereign Wealth Funds and Investment Law 167
Mauro Megliani
10 Common Characteristics of Rated Sovereigns Prior
to Default 1 82
Marie Cavanaugh, John B. Chambers, and
Maximillian McGraw
Part III Management of Sovereign Risk
and Ratings
11 Big Projects in Small Economies: The Determinants of
Sovereign Risk and Its Control 195
Sean J. Hinton, Brian S. Fisher, and Anna M. Fisher
12 Monetary Policy and International Reserves in Emerging
Economies: Theory and Empirics 213
Prakash Kumar Shrestha and Willi Semmler
13 Stock Market Impact of Sovereign Rating Changes:
Alternative Benchmark Models 231
Emawtee Bissoondoyal-Bheenick and Robert Brooks
14 Reserve Adequacy Measures for Emerging
Market Economies 2 53
Willi Semmler and Lebogang Mateane
15 The Price Impact of Sovereign Rating Announcements 275
Albert Metz and Merxe Tudela
Index 2 93
List of Figures
2.1 P robability of the high-volatility regime and default
probability for G1 3 9
2.2 P robability of the high-volatility regime and default
probability for P6 4 0
3.1 P robability to be in the state of high correlations:
sovereign bonds 5 3
3.2 P robability to be in the state of high correlations:
CDS Premiums 5 4
4.1 D aily returns series 6 7
4.2 C onditional variance of GARCH (1,1) model 74
4.3 E fficient frontier 7 5
8.1 I nformation sources for solicited, unsolicited and
co-operative ratings 1 63
10.1 N et external liabilities 1 84
10.2 A verage current account deficit in three years prior
to default 1 85
10.3 D epreciation of local currency against US dollar 186
10.4 G DP per capita (US$) 1 87
10.5 R eal GDP per capita growth 1 88
10.6 C hange in general government debt exceeds headline
deficit in years prior to default 189
10.7 N et general government debt 1 90
15.1 S overeign CDS spreads by whole-letter rating; average
spreads, emerging markets, 2005–February 2012 283
15.2 M ean spreads by type of rating announcement 283
vii
List of Tables
1.1 Equity returns vs. economic growth for the US and
UK – 112 years from 1900 to 2012 7
1.2 Equity returns vs. economic growth for emerging vs.
developed markets – 1988 through 2012 8
1.3 Economic growth vs. stock returns for 18 countries,
1971 to 2012 10
1.4 Ten years of growth vs. returns for 48 countries,
ranked from highest to lowest 13
1.5 Real returns regressed on earnings yield and real
GDP growth for 48 countries 13
2.1 Credit ratings of Central American long-term sovereign
bonds in November 2013 19
2.2 Descriptive statistics 23
2.3 Parameter estimates for Belize and Honduras 2 9
2.4 Parameter estimates for Costa Rica 31
2.5 Parameter estimates for Guatemala 33
2.6 Parameter estimates for Panama 35
2.7 Parameter estimates for El Salvador 37
2.8 Estimation results for the regime switching model for
G1 and P6 41
3.1 C orrelation matrix, sovereign bond yields 5 5
3.2 Correlation matrix, CDS premiums 55
4.1 Stock market descriptive statistics 66
4.2 Unit root tests on price levels and first differences 6 8
4.3 Correlation Coefficient Matrix for pre-EU period,
1995–2004 70
4.4 Correlation coefficient matrix for post-EU period,
2004–2009 71
4.5 Estimated GARCH (1,1) model on return series data 7 3
4.6 Optimal asset allocation 76
5.1 OFCs with their principal international financial
activity and gross domestic product (GDP) per capita
as per 2007 88
6.1 Early sovereign ratings 110
6.2 Number of rated sovereigns, 1990–2013 1 12
6.3 Developed and developing countries’ % share of world GDP 1 13
viii
List of Tables ix
6.4 A verage sovereign ratings, developed and
developing economies 114
6.5 A verage ‘rule of law’ index, developed and
developing economies 115
8.1 M ajor financial rating types and their focus 154
8.2 C omparison of the independence of rating
methodologies 1 63
8.3 C omparison of acceptability of different rating
methodologies 1 64
10.1 R ated sovereigns that defaulted on foreign currency debt 183
12.1 S ummary statistics of the variables used in the model 221
12.2 A DF test with constant 221
12.3 S tatistics for selecting lag orders 223
12.4 R esults from bound test for level relation 224
12.5 E stimation of level relationship in baseline model 224
12.6 E rror correction form of ARDL (p, p , p , p ) 2 25
1 2 3
12.7 S electing lag orders for the extended ARDL model 226
12.8 B ound test for level relation for the extended
ARDL model 2 27
12.9 E stimation of level relationship in the extended model 227
13.1 A verage abnormal returns (AAR) and cumulative
abnormal returns (CAR) as measures of the market
reaction to Standard & Poor’s (S&P) foreign currency
rating changes 240
13.2 A verage abnormal returns (AAR) and cumulative
abnormal returns (CAR) as measures of the market
reaction to Standard & Poor’s (S&P) foreign currency
rating changes 244
13.3 Average abnormal returns (AAR) and cumulative
abnormal returns (CAR) as measures of the market
reaction to Standard & Poor’s (S&P) foreign currency
rating changes 247
14.1 P ercentage point change in external debt measures
relative to total reserves 265
14.2 A bsolute change in ratio of M2 to total reserves and
growth rate of total reserves in months of imports 268
15.1 R obustness tests, emerging markets 288