Présentation PowerPoint - No Slide Title

1

15th World Congress of the International Economic Association

Sovereign Debt Crises through the Prism of Primary Bond

Market

Sebastian Nieto ParraSciences Po Paris, Chaire Finances

InternationalesOECD Development Centre

Istanbul, June 2008

2

Motivation• Inefficiency in sovereign bond markets

Asymmetries of information between capital markets’ actors

• Behaviour and interactions between the three

major actors of the Sovereign Bond Market :GovernmentsInvestment banks/lead managersInvestors

• It concerns the advantage of information that investment banks may have over investors.

3

Motivation

Governments Investment Banks

Investors

feePt

)( tTPC )( tt PCP tT

P

Where:

T: Maturity date

t: Issue date

C: Commission paid by investors to Investment banks

P: Price of the sovereign bond (Financial transaction that

it is the counterparty of the transfer of the security).

fee : Underwriting spread paid by governments to investment banks

TP

Structure of the Prices in the Sovereign Bond Market

4

Motivation• Primary and secondary sovereign bond markets

provide important information concerning risk perception of capital markets’ actors

Risk perception of investors can be measured by theSovereign bond spreads on the primary and secondary market

Risk perception of investment banks can be measured by the remuneration that governments pay to investment banks in order to place bonds (i.e., underwriting fee)

5

Review of the literature• Information problems in the emerging sovereign

bond market - Flores (2007), and Flandreau and Flores (2007): Historical point of view.

Role of underwriters as providers of information for investors.- Nieto-Parra and Santiso (2007): Positive recommendations given by

Investment Banks when they are acting as Lead Managers.- Edwards (1997): Information pb between Wall Street analysts and their

clients during the Mexican crisis of 1994- Blustein (2003): Conflict of interest with which Investment banks are

faced during the Argentinean crisis of 2001.

- Calomiris (2003): Cooperation between research and origination departments.

They are not followed by a systematic analysis of the structureof the primary bond market. Information problems for the recent sovereign debt crises.

6

Review of the literature• Vast and relevant research literature on the

primary corporate bond market

1 Literature related to the determinants of the underwriting fee:

- West (1967), Sorensen (1979), Higgins and Moore (1980), Kryzanowski et al. (1996), Lee et al. (1996), Altinkihc and Hansen (2000), How and Yeo (2000), Livingston and Miller (2000), Kollo and Sharpe (2002), Livingston and Zhou (2002) and Hua-Fang, (2005)

Credit risk and profitability indicators are explanatory variables of the underwriting fee.

2 Relationship between the primary market and the recommendations given by underwriters:

- Lin and McNichols (1998), Chen and Ritter (2000), Ljungqvist et al. (2006), Bradley et al. (2003), and Michaely and Womack (1999).

7

Description of the data• Period: 1993-2006• Frequency: Annual• 29 Countries: EMBI Index (JP Morgan) and countries for

whom we have information on underwriting feeArgentina, Brazil, Bulgaria, Chile, China, Colombia, Dominican Republic, Ecuador, Egypt, El Salvador, Hungary, Indonesia, Lebanon, Malaysia, Mexico, Morocco, Pakistan, Panama, Peru, Philippines, Poland, Russia, South Africa, Thailand, Turkey, Ukraine, Uruguay, Venezuela and Vietnam.

1 Structure of the primary bond market (Underwriting fee and Primary sovereign bond spread):Standard issues: (i) ISIN reference number

(ii) Coupon rate is not float (iii) Currency denomination (EUR, JPY,

USD) (iv) No guarantee for the issue

8

Description of the data427 issues (67% denominated in USD, 28% in EUR and 5% in JPY)

Annual average of the underwriting fee and primary sovereign bond spread of the emerging countries

2 Secondary Sovereign bond spread (EMBI Index,

JPMorgan)

3 Information received by investors from investment banks concerning the primary bond marketwe collect the major investment banks’ publications published by the most important financial actors in emerging countries.

9

Sovereign Debt Crises• Standard definition employed mostly on the “early warning

models”, a country is defined to be in a debt crisis if:1. It is classified as being in default by Standard & Poor’s (S&P’s) ,

OR2. It receives a large non-concessional IMF loan defined in excess of

100 percent of quota.

A variety of crises:1. S&P’s default: two groups depending on the restructuring case (Pre-emptive

and post-default)2. IMF loans: two groups depending on the vulnerability of public sector (i.e.,

risk of default of sovereign bonds).

10

Sovereign Debt Crises

Brazil (August 2001)

Turkey (Dec. 2000)*

Brazil (Dec. 1998)*

Mexico (Feb 1995)*

Thailand (Aug.1997)*

Indonesia (Nov. 1997)*

SOVEREIGN DEBT CRISES

Pre-emptive No PBVPost defaultPublic Bonds

DEFAULT (S&P's definition) IMF large package

Argentina (Nov. 2001)*

Ecuador (Sept. 1999)

Vulnerabilities (PBV)

Ukraine (Sept. 1998)*

Dom. Rep. (Feb. 2005)*

Uruguay (May 2003)*

Pakistan (Jan. 1999)

Russia (August 1998)*

Note: * denotes countries that experienced also a currency crisis during the 12 months prior and following the sovereign debt crisis. See next section for the definition of currency crises.

Sovereign Risk Countries

11

HypothesisEfficiency of the sovereign bond market

Market inefficiencies can arise when information is often asymmetrically held by market participants.

• In order to test market inefficiency in the emerging sovereign bond market, the null hypotheses used are the following:

Hypothesis 1: Prior to sovereign debt crises, investors are not perfectly informed on the quality of the sovereign bonds issued by risk countries. By contrast, investment banks observed this risk before the onset of crises.

Hypothesis 2: This asymmetric information is above all present in sovereign risk countries exposed with high public finances difficulties.

12

HypothesisEfficiency of the sovereign bond market

These hypotheses are validated when :

H1: Prior to sovereign bond crises investment banks demand a high underwriting fee for “bad” countries with respect to the sovereign bond spread priced by investors for these countries.

H2: By differentiating among sovereign debt crises, we note this effect is above all existent on countries that present sovereign risk difficulties.

13

Stylized Facts

Fee vs. Primary Sovereign Bond Spread(T is the crisis entry)

0,2

0,3

0,4

0,5

0,6

0,7

0,8

0,9

1

1,1

1,2

T-3 T-2 T-1 T T+1 T+2 T+3

Source: The author based on Dealogic, 2007

300

350

400

450

500

550

600

Fee Average (%)

Primary Sovereign BondSpread Average (bp; rhs)

Fee vs. Secondary Sovereign Bond Spread(T is the crisis entry)

0,2

0,3

0,4

0,5

0,6

0,7

0,8

0,9

1

1,1

1,2

T-3 T-2 T-1 T T+1 T+2 T+3

Source: The author based on Dealogic and Datasteram, 2007

400

600

800

1000

1200

1400

1600

1800

Fee Average (%)

Secondary Sovereign BondSpread Average (bp; rhs)

Fees and Sovereign Bond Spreads during Crises

(Annual Basis)

14

Stylized FactsFees and Sovereign Bond Spreads

during different types of Crises

Fee vs. Sovereign Bond SpreadsPost default and IMF Package Public Bonds Vul. cases(T is the crisis entry)

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

1,8

T-3 T-2 T-1 T T+1 T+2 T+3


300

500

700

900

1100

1300

1500

1700

1900

Fee Average (%)



Fee vs. Sovereign Bond SpreadsPre-emptive and IMF Package No Public Bonds Vul. Cases (T is the crisis entry)

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

1,8

T-3 T-2 T-1 T T+1 T+2 T+3


-100

100

300

500

700

900

1100

1300

1500

Fee Average (%)



No Sovereign Risk CountriesSovereign Risk Countries

15

Stylized FactsUnderwriting and Primary Sovereign Bond Spreads

1993-2006 (Annual basis)

Viet. Ven.

Ven.

Ven.

Ven.

Ven.

Ven.

Ven.

Urug.

Urug.

Urug.

Urug.

Urug.Urug.

Urug.

Urug.

Urug.

Urug. Urug.

Uk.

TurkeyTurkey

Turkey

Turkey

TurkeyTurkey

Turkey

Turkey(T-1)

Turkey(T-2)

Turkey(T-3)

Turkey Turkey

Turkey

Thai.

Thai.

S.AfricaS.Africa

S.Africa

S.Africa

S.Africa

S.Africa

S.Africa

S.Africa

Rus.Rus.(T-1)

Rus.(T-2)

P ol.P ol.

P ol.

P ol.P ol.

P ol.

P ol.

P ol.

P hilip.P hilip.

P hilip.P hilip.

P hilip.

P hilip.

P hilip.

P hilip.P hilip.

P hilip.

P eru P eru P eru

P eru

P an.

P an.P an.

P an.

P an.

P an.

P an.

P an.

P an.

P ak.

P ak.

Mor.Mor.

Mex.

Mex.

Mex.Mex.

Mex.

Mex.

Mex.

Mex.

Mex. Mex.

Mex.

Mex.(T-2)

Mal.Mal.

Mal.

Leb.Leb.

Leb.Leb.

Leb.Leb.Leb.

Leb.Leb.Leb.

Ind.Ind.

Ind.

Hung.

Hung.Hung.

Hung.

Hung.

Hung.

El Sal.

El Sal.

El Sal.

El Sal.Egypt

Ecu.

Dom.Rep.

Col.

Col. Col.

Col.

Col.

Col.

Col.

Col.

Col.

Col.Col.

Col.

China

ChinaChinaChina

ChinaChina

China

China

China

China ChileChile

ChileChile

Bul. Bul.

Brazil

Brazil

Brazil Brazil

Brazil

Brazil

Brazil

Brazil

Brazil

Brazil(T-1)

Brazil(T-2)

Arg.

Arg.(T-1)

Arg.(T-2)

Arg.(T-3)

Arg.

Arg.

Arg.

Arg.

Arg.

0

0,2

0,4

0,6

0,8

1

1,2

1,4

1,6

1,8

0 100 200 300 400 500 600 700 800 900

Fee (%)

Primary Bond Spread (bp.)

16

Econometric analysis

where is the underwriting spread received by investment banks from country i in period t, is the sovereign bond spread (i.e., primary or secondary bond spreads) and it is taken in basis points (bp) is a dummy variable that takes the value of 1 for countries placed prior to the onset of a sovereign debt crisis (between T-3 and T-1) and 0 otherwise. is defined as the product of SBS and crisis is a time dummy variable.

itiitititit TSBScrisiscrisisSBSfee 54321

itfee

itSBS

itcrisis

itSBScrisis

iT

OLS and Fixed Time Effect estimation

17


Dependent variable: Fee

I II III IV V VI VII VIII IX

Primary Sovereign Bond Spread (SBS ) 0.000342*** 0.000257** 0.000289** 0.000343*** 0.000356*** 0.000219* 0.000274** 0.000264** 0.000280**(2.65) (2.12) (2.30) (2.65) (2.72) (1.84) (2.27) (2.31) (2.40)

Sovereign Debt Crises (crisis ) 0.35750*** 0.52239***(5.25) (2.78)

No Public Bond Difficulties (crisis ) 0.01504 0.23692(0.10) (0.75)

Public Bond Difficulties (crisis ) 0.44217*** 0.94235***(5.92) (3.83)

Public Bond Difficulties and Currency crises (crisis ) 0.57120*** 0.75583***(6.92) (2.86)

Interactive dummy (SBScrisis ) - 0.00043 - 0.00083 - 0.00121** - 0.00048(-0.94) (-0.80) (2.13) (-0.74)

Cons 0.45246*** 0.43965*** 0.42969*** 0.45192*** 0.44771*** 0.45241*** 0.43558*** 0.44014*** 0.43538***(9.64) (10.07) (9.56) (9.54) (9.38) (10.57) (10.11) (10.59) (10.34)

N (Observations) 170 170 170 170 170 170 170 170 170

Adjusted R-squared 0.0345 0.1665 0.1659 0.0288 0.0267 0.1974 0.2141 0.2449 0.2429t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.

(1993 - 2006) Annual Data

Undewriting Fee, Primary Sovereign Bond Spread and Soveregn Debt Crisis

1. An increase of 100 bp of the bond spread only implies an increase of 0,03 per cent of the underwriting fee. 2. H1: On average prior to crisis, countries paid 0,52 per cent of extra fee. This variable is statistically significant at 1 per cent. 3. H2: When we take into account ONLY sovereign risk countries, the fixed cost that these countries have to pay to investment banks is high (0,94 per cent of the proceeds).

18


Dependent variable: Fee

I II III IV V VI VII VIII IXPrimary Sovereign Bond Spread (SBS ) 0.000432*** 0.00039*** 0.000409*** 0.000432*** 0.000434*** 0.000363*** 0.000391*** 0.00037** 0.000369**

(4.80) (4.43) (4.52) (4.76) (4.75) (4.12) (4.43) (4.53) (4.47)Sovereign Debt Crises (crisis ) 0.16648*** 0.27861***

(3.41) (2.07)No Public Bond Difficulties (crisis ) -0.00047 0.04411

(-0.00) (0.21)Public Bond Difficulties (crisis ) 0.21430*** 0.55234***

(3.92) (3.09)Public Bond Difficulties and Currency crises (crisis ) 0.35271*** 0.34053*

(6.14) (1.84)Interactive dummy (SBScrisis ) - 0.00029 - 0.000167 - 0.00082** 0.00003

(-0.90) (-0.24) (-1.99) (0.07)Year 1994 (T ) -0.9252 -0.07063 -0.06250 -0.09253 -0.09244 -0.06503 -0.03976 -0.04496 -0.04580

(-0.90) (-0.71) (-0.62) (-0.90) (-0.89) (-0.66) (-0.40) (-0.48) (-0.49)Year 1995 (T ) 0.05713 0.07884 0.08710 0.05713 0.05723 0.08433 0.10972 0.10443 0.10360

(0.51) (0.72) (0.79) (0.51) (0.50) (0.78) (1.02) (1.03) (1.01)Year 1996 (T ) -0.04233 -0.06515 -0.06891 -0.04230 -0.04477 -0.05266 -0.04397 -0.05786 -0.05822

(-0.45) (-0.72) (-0.76) (-0.45) (-0.47) (-0.59) (-0.50) (-0.69) (-0.69)Year 1997 (T ) 0.12083 0.09848 0.10391 0.12082 0.12091 0.09144 0.10221 0.09809 0.09776

(1.37) (1.15) (1.21) (1.37) (1.36) (1.08) (1.22) (1.24) (1.23)Year 1998 (T ) -0.08482 -0.09683 -0.08744 -0.08482 -0.08509 -0.09817 -0.07146 -0.08453 -0.08567

(-0.92) (-1.08) (-0.97) (-0.92) (-0.92) (-1.11) (-0.81) (-1.02) (-1.01)Year 1999 (T ) -0.19399** -0.19972** -0.18354** -0.1940** -0.19417** -0.20** -0.15432** -0.18498** -0.18644**

(-2.19) (-2.33) (-2.10) (-2.19) (-2.18) (-2.36) (-1.78) (-2.33) (-2.26)Year 2000 (T ) -0.18536** -0.19484** -0.18598** -0.18533** -0.18568** -0.18138** -0.14753** -0.15657** -0.15747*

(-2.08) (-2.26) (-2.14) (-2.06) (-2.06) (-2.12) (-1.71) (-1.95) (-1.93)Year 2001 (T ) -0.39163*** -0.37188*** -0.36895*** -0.39160*** -0.39221*** -0.35394*** -0.33286*** -0.33485*** -0.33558***

(-4.61) (-4.51) (-4.47) (-4.58) (-4.57) (-4.32) (-4.07) (-4.35) (-4.31)Year 2002 (T ) -0.39932*** -0.38363*** -0.37610*** -0.39928*** -0.39633*** -0.35917*** -0.33910*** -0.34031*** -0.34102***

(-4.32) (-4.29) (-4.18) (-4.29) (-4.21) (-4.04) (-3.82) (-4.07) (-4.04)Year 2003 (T ) -0.52629*** -0.49944*** -0.49357*** -0.52630*** -0.52643*** -0.49063*** -0.46871*** -0.47134*** -0.47209***

(-5.96) (-5.82) (-5.73) (-5.94) (-5.92) (-5.77) (-5.52) (-5.90) (-5.84)Year 2004 (T ) -0.55142*** -0.52708*** -0.52006*** -0.55142*** -0.55144*** -0.51988*** -0.49627*** -0.50020*** -0.50099***

(-6.26) (-6.16) (-6.05) (-6.24) (-6.22) (-6.14) (-5.86) (-6.28) (-6.21)Year 2005 (T ) -0.55111*** -0.5280*** -0.52042*** -0.55111*** -0.55110*** -0.52160*** -0.49716*** -0.50172*** -0.50253***

(-6.11) (-6.03) (-5.91) (-6.09) (-6.07) (-6.02) (-5.73) (-6.16) (-6.08)Year 2006 (T ) -0.57220*** -0.55153*** -0.54283*** -0.57220*** -0.57206*** -0.54671*** -0.52062*** -0.52645*** -0.52730***

(-5.89) (-5.85) (-5.73) (-5.87) (-5.85) (-5.87) (-5.58) (-6.00) (-5.94)Cons 0.69821*** 0.68617*** 0.67354*** 0.69822*** 0.69767*** 0.68696*** 0.65501*** 0.66533*** 0.66631***

(9.07) (9.21) (8.87) (9.04) (9.00) (9.32) (8.76) (9.59) (9.38)

N (Observations) 170 170 170 170 170 170 170 170 170

Adjusted R-squared 0.5980 0.6238 0.6234 0.5954 0.5929 0.6320 0.6390 0.6750 0.6729t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.

Undewriting Fee, Primary Sovereign Bond Spread and Soveregn Debt Crisis

(1993 - 2006) Annual Data

19

Fee and financial markets’ actors

1. Availability of this information:Bloomberg and Dealogic

However it is not accessible at the day of the issue:According to a member team of Dealogic at the end of 2007 “for about 80

% of large deals (more than US$200m equivalent) we should have the fee within 1 day”.

Impact on secondary market prices…

2. Do investors concern themselves with underwriting fees?

Questionnaire to investors in Wall Street

(Alliance Bernstein, Alliance Capital, Fidelity, GE Asset Management, GMO, Goldman, Invesco and Western Asset)

20


Seven investors of the eight interviewed argue that underwriting fee is of no concern in investment decisions. Moreover they do not perceive underwriting fee as a good indicator of credit risk.

3. Investment banks’ publications on emerging sovereign bond markets.12 investment banks covering the period 1997-2007 ABN

AMRO, Barclays Capital, Bear Stearns, Citigroup, Credit Suisse, Deutsche Bank, Dresdner Kleinwort

Wasserstein, Goldman Sachs, JP Morgan, Lehman Brothers, Merrill Lynch and Morgan Stanley.

Underwriting fee is not a piece of information given by investment banks to institutional investors.

21


4. Why, therefore, do investors not pay attention to the evolution of underwriting fees?

This is puzzling in that useful, publicly available information is not tracked by investors to help improve allocation of their emerging market fixed income assets.

22

Conclusions1. investment banks price sovereign default risk well before crises and

even before investors. This result suggests that investment banks hold an information advantage over investors

2. Investment banks’ behaviour differs depending on the type of sovereign debt crisis. Before crises investment banks charged a higher underwriting fee to countries presenting public bond vulnerabilities with respect to other sovereign crises.

3. There is a puzzle in that it appears that investors are not using potentially useful (and public) information in order to allocate efficiently their portfolios.

Documents

Présentation PowerPoint - No Slide Title