The Sensitivity Of Secondary Sovereign Loan Market Returns To Macroeconomlc Fundamentals

The sensitivity of secondary sovereign loan market returns to three classes of economic news is estimated in the arbitrage pricing theory framework. Returns are characterized by a limited response to unexpected changes in procyclical U.S. aggregates. Shocks to country-specific balance of payment indicators do not impact debt prices. Announcements of policy changes by creditors and third parties that presage changes in future lending induce large debt price changes. The failure of the data to meet the empirical arbitrage pricing theory restrictions and the large proportion of return variance unexplained by macroeconomic fundamentals highlight the differences between corporate and sovereign securities.

The insensitivity of sovereign loan secondary market returns to macroeconomic fundamentals has been attributed to market illiquidity and the absence of publicly reported transactional prices. During the 1920s and 1930s sovereign bonds were traded in an active market and weekly transactional prices were publicly available. This paper shows that price changes from both eras are insensitive to unexpected changes in key external and country-specific macroeconomic aggregates, but that returns are moved by individual agent announcements that presage changes in future lending. The results, which contrast with studies of U.S. equities, indicate that the sovereignty of the issuer matters more than the type of debt contract.

The risk that the debtor country will default on its external debt may be significantly decreased by a debt-reduction operation, by a reduction in international interest rates, and by changes in the country's willingness to pay.

Under what circumstances can market forces prevent unsustainable borrowing? Effective market discipline requires that capital markets be open, that; information on the borrower’s existing liabilities be readily available, that no bailout be anticipated, and that the borrower respond to market signals. This paper explores the implications of these conditions, and reviews some relevant empirical evidence.

This note examines the impact of measurable and unmeasurable (not correlated with observed aggregates) information on secondary market LDC loan prices. The Institutional Investor country risk ratings are used to construct a proxy for the non-quantifiable information that moves debt market values. Regression results indicate that market participants use both macroeconomic aggregates and unmeasurable information to price LDC loans. This implies that price changes unrelated to observables need not raise concerns regarding price reliability, and, in fact, such price movements may well be conveying important information not quantified elsewhere.

This paper presents the IMF’s annual survey of developments, prospects, and key policy issues in international capital markets. It focuses on how to manage the restructuring of capital markets in an environment of wide-ranging liberalization, intense competition, and growing securitization—in a way that avoids a systemic crisis as well as moral hazard risks and budgetary costs associated with public sector support of weak financial institutions. A key feature of the new financial environment is the competition-driven disintermediation from banking systems—particularly from wholesale banking—into securitized money and capital markets. The more creditworthy corporate borrowers in major industrial countries are increasingly able to satisfy their liquidity, risk-management, and financing needs directly in liquid securities markets. Securitization is forcing adjustments across the entire spectrum of activities and institutions in financial markets. The loss of traditional balance sheet business has led to cost cutting and to consolidation in the wholesale banking sector and to an expansion in off-balance sheet activities, including backup lines of credit and forward interest rate and foreign exchange contracts.