The anatomy of sovereign risk contagion

The channels for the cross-border propagation of sovereign risk in the international sovereign debt market are analysed. Identifying sovereign credit events as extraordinary jumps in CDS spreads, we distinguish between the immediate effects of such events and their longer term spillover effects. To analyse “fast and furious” contagion, we use daily CDS data to conduct event studies around a total of 89 identified credit events in a global country sample. To analyse “slow-burn” spillover effects, we apply a multifactor risk model, distinguishing between global and regional risk factors. We find that “fast and furious” contagion has been primarily a regional phenomenon, whilst “slow-burn” spillover effects can often be global in scope, especially those of the recent European debt crisis. The global risk factors are found to be driven by investor risk appetites and debt levels, whilst the regional factors depend on economic fundamentals of countries within a region

Regional Financial Integration in East Asia against the Backdrop of Recent European Experiences

This article discusses recent trends in regional financial integration in East Asia and current efforts of the Association of Southeast Asian Nations (ASEAN) member countries to foster regional financial integration against the backdrop of three decades of experience with financial integration in Europe. It reviews the two major crisis episodes of the recent European financial history to illustrate the risks associated with comprehensive capital account liberalisation and financial integration without commensurate supervisory structures. The article highlights the importance of targeted macroprudential policies and the development of an adequate region-wide regulatory and supervisory framework to reduce the risks associated with regional – and hence international – financial integration

Inflation Risk Premia in the US and the Euro Area

We use a joint model of macroeconomic and term structure dynamics to estimate inflation risk premia in the United States and the euro area. To sharpen our estimation, we include in the information set macro data and survey data on inflation and interest rate expectations at various future horizons, as well as term structure data from both nominal and index-linked bonds. Our results show that, in both currency areas, inflation risk premia are relatively small, positive, and increasing in maturity. The cyclical dynamics of long-term inflation risk premia are mostly associated with changes in output gaps, while their high-frequency fluctuations seem to be aligned with variations in inflation. However, the cyclicality of inflation premia differs between the US and the euro area. Long term inflation premia are countercyclical in the euro area, while they are procyclical in the US

The dynamic pricing of sovereign risk in emerging markets: Fundamentals andrRisk aversion

This article presents an analysis of the sovereign risk pricing in emerging markets. Analyzing pricing of sovereign risk is important for bond portfolio management, risk management and regulation of financial institutions. The difficulty in analyzing sovereign spreads is how to distinguish between risk and the pricing of risk as financial compensation demanded by investors for bearing sovereign default risk. Sovereign debt spreads were decomposed into two market-based components, namely the expected loss from default and the default risk premium. It found that risk premia and sovereign risk behave differently

Emergence of Captive Finance Companies and Risk Segmentation in Loan Markets: Theory and Evidence

A seller with some degree of market power in its product market can earn rents. In this context, there is a gain to granting credit to purchase of the product and thus to the establishment of a captive finance company. This paper examines the optimal behavior of such a durable good seller and its captive finance company. The model predicts a critical difference between the captive finance company's credit standard and that of independent lenders ("banks"), namely, that the captive finance company will adopt a more lenient credit standard. Thus, we should expect the likelihood of repayment of a captive loan to be lower than that of a bank loan, other things equal. This prediction is tested using a unique data set drawn from a major credit bureau in the United States, and the evidence supports the theoretical prediction. Copyright 2008 The Ohio State University.

Aggregate market returns and UK unit trust net acquisitions

Recent US research has focused upon the linkages between net mutual fund flows and their impact upon aggregate equity market returns. If a positive feedback relationship exists between investment flows and stock returns then there also exists the possibility that a market downturn or crash will be exacerbated by corresponding net outflows as mutual fund investors withdraw funds, forcing equity prices down further and thus creating a vicious circle. Using data from the UK we analyse the relationship between aggregate equity market returns and the net flows into UK unit trusts. We also undertake a similar exercise using UK bond market data. We trace our failure to identify a positive feedback relationship to the structure of the UK's unit trust industry. The fee structure, the relatively low minimum lump sum values, and the availability of regular savings unit trusts all combine to bring about a very low turnover of unit trust units in the UK.