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The Determinants of Corporate Bond Yield Spreads

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Title: The Determinants of Corporate Bond Yield Spreads


1
  • The Determinants of Corporate Bond Yield Spreads
  • in South Africa Firm-Specific or Driven by
    Sovereign Risk?

Martin Grandes (DELTA and OECD Development
Centre, Paris) Marcel Peter (HEI Geneva and IMF)
2
This presentation
  • Motivation and policy relevance
  • What do we know about it?
  • The determinants of corporate default risk premia
    in theory
  • Firm-specific variables
  • Sovereign default risk
  • Empirical evidence for South African corporates
  • Data sources and sample period
  • Econometric framework
  • Results
  • Concluding remarks and policy recommendations

3
Motivation and Policy Relevance
  • Global
  • Feeds into the Post-Monterrey agenda
  • Cheaper finance for development, debt
    sustainability
  • Higher rates of investment required in LDCs to
    achieve MDG
  • Regional
  • Contributes to NEPAD Capital Flows Initiative
    (CFI) and the NEPAD-OECD Africa Investment
    Initiative
  • Aim increasing private capital flows to Africa,
    filling the resource gap
  • Two priorities
  • i) address investors perception of Africa as a
    "high-risk" continent
  • ii) promote the deepening of financial markets
    within countries, as well as cross-border
    harmonisation and integration. Positive spillover
    effects.
  • (see OECD DEV WP 231 or session I tomorrow!)

4
Motivation and Policy Relevance
  • Domestic
  • Researches a unique case in Africa,
  • A liquid bond market in local currency. Yet,
    small truly corporate bond market but
  • Good prospects for further development (see RMB
    and BESA)
  • Big firms tapping this market. Could help inform
    decisions made by other potential issuers gt
    alternative, cheaper source of finance
  • Scope for lowering corporate debt costs when
    public solvency improves
  • Source of concern
  • The cost of capital (of which debt cost is a
    component) is a critical driver of long-term
    growth.
  • Relatively high real cost of capital blamed for
    sluggish long-term growth (see also Michael
    Powers presentation)

5
What do we know about it?
  • Main questions this study aims to answer
  • 1) Can we observe something like a sovereign
    ceiling in local-currency-denominated corporate
    bond yield spreads?
  • In other words, Is a given increase in sovereign
    risk associated with a more or less than
    proportionate increase in South African corporate
    bond yield spreads?
  • 2) Do idiosyncratic (i.e. company-specific)
    factors help explain corporate default risk
    premia?
  • Very scant literature on developing countries.
  • Virtual inexistence of long-term, fixed rates,
    local-currency denominated issues (Original
    Sin)
  • Many corporate bond markets still poorly
    developed
  • Only Durbin and Ng (2001) foreign-currency
    denominated issues no firm-specific controls.
    Main finding the sovereign ceiling doesnt
    hold, esp. in low-risk countries

6
The determinants of corporate default risk
premia. Theory
The Cost of debt for an emerging market borrower

This morning
This presentation
7
The determinants of corporate default risk
premia. Theory
  • Firm-specific variables (Black and Scholes, 1973
    Merton, 1974 Shimko et al (1993), others)

8
The determinants of corporate default risk
premia. Theory
  • Sovereign default risk and the sovereign ceiling

if
gt the ceiling in spreads applies
if
gt the ceiling in spreads does not apply In
this latter case, corporate spreads higher than
sovereign spreads due to higher firm stand-alone
risk
9
Empirical evidence for South African corporates
  • Data sources and sample
  • BESA and DATASTREAM.
  • Excludes parastatals
  • Excludes non-listed (at JSE) corporates
  • Excludes illiquid issues
  • gt We found 12 bonds October 1997-May 2003.
    Monthly observations
  • Half banks, half industrials
  • Benchmark bonds EBRD, EIB and IBRD (World Bank)
    ZAR denominated issues
  • Econometric framework
  • Panel data estimations. Modern techniques. Two
    equations
  • Corporate spread levels
  • Corporate spread differences

Therefore, task is to test the significance and
value of
10
How do we compute corporate spreads?
Example I ABSA 05
In points
11
How do we compute corporate spreads?
Example II ISCOR 03
In points
12
Empirical evidence for South African corporates
  • Econometric results

Type of Risk Variable Variable Impact on Corporate Default Spreads Impact on Corporate Default Spreads
Type of Risk Variable Variable Expected Estimated
Systematic Sovereign default risk Sovereign default risk
Firm-specific Leverage (quasi-debt to firm value ratio) Leverage (quasi-debt to firm value ratio)
Firm-specific Firm value volatility Firm value volatility
Firm-specific Time to maturity Time to maturity /- -
Firm-specific Risk-free interest rate volatility Risk-free interest rate volatility /-
Firm-specific Liquidity Liquidity -
Firm-specific Interaction Terms Leverage ? Time to Maturity /-
Firm-specific Interaction Terms Leverage ? Risk-free interest rate volatility /-
Note and means the variable is
statistically significant at the 1 and 5 level,
respectively.
13
Main results policy recommendations
  • Indirect sovereign risk is less than 100
  • Hence, the sovereign ceiling as defined does
    not apply for local-currency bond issues
  • Corporate default risk is also explained by
    relatively higher firm stand-alone risk. This is
    due, according to our findings, to
  • An increase in the firms leverage
  • A rise in the volatility of returns on the firm
    value
  • Shorter remaining time to maturity
  • Higher risk-free interest rate volatility, when
    firms are highly leveraged
  • However, sovereign risk is still an important
    determinant of corporate debt cost!
  • Scope for policies targeting public sector
    solvency

14
Annex
South African Corporate spreads I
Basis points
15
Annex
South African Corporate spreads II
Basis points
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