Campbell R. Harvey
Duke University and NBER
Andrew H. Roper
Duke University
Crisis, Emerging Markets, and Risk
Emerging markets can provide substantial
returns to foreign investors. However,
emerging markets also introduce investors to
new sources of economy/region wide risks
not present in more developed markets.
•Latin Debt Crisis (1980)
•Mexican Peso Crisis (1994)
•Asian Crisis (1997)
•Russian Ruble Crisis (1998)
•Brazilian Real Crisis (1999)
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Crisis, Emerging Markets, and Risk
In order to understand the risk of investing in
emerging markets, we must understand these
crises.
•What were the causes (indicators) of the crisis?
•What were the remedies (resolutions) of the crisis?
Both involve risks!
We will focus on the first.
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Crisis, Emerging Markets, and Risk
Crises are “worst case” scenarios for foreign
investors.
•Increased political risk
Crises tend to follow periods of political change and the resolution of
•Increased
crisis usually
currency
involves risk
dramatic changes from the status quo policy. Capital
controls,
appropriation
of private
corporates,
and ingovernment
Crises
aregovernment
often accompanied
or triggered
by dramatic
changes
exchange
led corporate
restructuringimpose
are common
during
the resolution
of
rates.
Government’s
capital place
controls
and/or
strict guidelines
•Increased
financialoften
risk
oncrises.
foreign exchange rate transactions during crises.
Crises lead to liquidity shortages as domestic financial institutions face
large amounts of non-performing loans and foreign lenders reconsider the
risk/return relationships in the region.
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
The Signs on the Wall
Early “Indications” of the Crisis to Come
Hanbo Steel collapsed under large debt service obligations
in Jan-97. The following month, Somprasong failed to meet
its foreign debt obligations.
“I don’t see any reason for the crisis to develop further.”
Managing Director of the IMF (Jan-97)
In May-97, the Thai government suspended operations of
Finance One.
“We will never devalue the baht.”
Prime Minister of Thailand (May-97)
In June-97 Thailand suspended 16 cash strapped
finance companies.
“We will never devalue the baht.”
PrimeAsian
Minister
(June-97)
"The
Bet"ofbyThailand
Campbell
R.
Harvey and Andrew H. Roper
Learning from the Past
Prescribing the causes of the crisis ex-post can be
detrimental and uninformative. In order to not be
trapped into a sense of false sense of security, we
should seek instead to uncover characteristics which
helped to promulgate the crisis.
First, we look at the usual suspects.
•Macroeconomic imbalances
•Asset price bubble
•Foreign speculators
•Micro (firm level) analysis
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Stock Market Return Performance
Setting the Record Straight
450
Taiwan
Thai Baht
Devaluation
Indonesia
Korea
350
Malaysia
Philippines
The return performance
of East Asian stock
Thailand
across countries. However, during
250 markets varied
USA
200 the 1990s the return performance throughout
150 East Asia lagged behind the US market.
300
100
50
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Sep
-98
98
Jan-
May
- 97
Sep
-96
96
Jan-
May
- 95
Sep
-94
94
Jan-
May
- 93
Sep
-92
92
Jan-
May
- 91
Sep
-90
90
0
Jan-
Portfolio Value ( Initial Investment = $100 )
400
Foreign Equity Investment
Net Purchases of Foreign Equity by US Investors
1000
East Asia (Ex-Taiwan)
Taiwan experiences $283 million capital outflow.
600
400
200
0
-200
98
Sep
-98
Jul-
98
-98
May
- 98
Mar
Jan-
97
Sep
-97
Nov
-97
Jul-
97
-97
May
- 97
Mar
Jan-
96
Sep
-96
No v
-96
Jul-
95
Sep
-95
Nov
-95
Jan96
Mar
-96
May
- 96
Jul-
95
-95
May
- 95
Mar
ia
Ex
A s ia (
s
st
Ea st A
Ea
-400
Jan-
Net US Equity Investment
800
East Asia
a
-T
a
iw
n)
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Micro Level Stylized Facts
As the 1990s progressed . . .
•Asian corporations experienced a decline in
performance.
•Asian corporate managers increased the
leverage of their firms.
•Asian corporate managers borrowed
substantially from international capital markets
in foreign currencies (US Dollars).
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Trends in Corporate Profitability
Country Comparisons
Median ROIC Across Countries
14
12
10
8
1992
1996
6
4
land
Thai
Taiw
an
s
ppin
e
Phili
Mala
ysia
Kore
a
0
Indo
nesia
2
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Trends in Corporate Leverage Ratios
Country Comparisons
Median Leverage Across Countries
250
200
1992
1996
150
100
Rating
Ratio
AAA
13.4
AA
21.9
A
32.7
BBB
43.4
BB
53.9
B
65.9
50
land
Thai
Taiw
an
s
ppin
e
Phili
Mala
ysia
Kore
a
Indo
nesia
0
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Trends in Corporate Coverage Ratios
Country Comparisons
Median EBITDA by Interest Payable
10
9
8
7
6
5
4
3
2
1
0
AAA
20.3
AA
14.94
A
8.51
BBB
6.03
BB
3.63
B
2.27
land
Ratio
Thai
Taiw
an
s
ppin
e
Phili
Mala
ysia
Kore
a
Indo
nesia
1992
1996
Rating
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Financial Risk of Foreign Debt
A firm’s leverage ratio encompasses all forms
of debt, including foreign debt. When we
think about the financial risk of debt, we need
to consider both the maturity of the debt and
the denomination of the debt.
In general, Asian corporate borrowed short
term and often times in dollar denominated
issues.
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Trends in External Financing
International Bond Offerings from East Asia
$35,000
$30,000
Dollar
Total
$25,000
$20,000
$15,000
$10,000
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
1997
1996
1995
1994
1993
1992
1991
$0
1990
$5,000
The Next Logical Step is Value at Risk
The substantial foreign exchange exposure of
Asian corporation is difficult to quantify with
standard methods.
•For
example,astandard
riskRisk
analysis
would regress
However,
Value at
analysis
couldstock
havereturns
on
the foreign potential
exchange rate
change. Thisthroughout
statistical measure
uncovered
weaknesses
the
would suggest no significant exchange rate exposure.
region prior to the crisis.
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Value at Risk: The Next Logical Step
Harvey and Roper (1999) suggested this
analysis. Their proposed exercise was simple.
Using detailed data on firm’s debt liabilities,
we can stress test a firm’s coverage ratio under
various interest rate and exchange rate
scenarios.
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Value at Risk: Illiquid Firms
0.7
Both
FX Shock
Mala
ysia
0.8
Kore
a
Sensitivity Analysis of Coverage Ratio
Interest Rate Shock
0.6
0.5
0.4
0.3
0.2
0.1
land
Thai
Taiw
an
s
ppin
e
Phili
Indo
nesia
0
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
Value at Risk: Insolvent Firms
Both
FX Shock
Mala
ysia
0.7
Kore
a
Sensitivity Analysis of Coverage Ratio
Interest Rate Shock
0.6
0.5
0.4
0.3
0.2
0.1
land
Thai
Taiw
an
s
ppin
e
Phili
Indo
nesia
0
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper
The Asian Bet
We conclude . . .
Asian corporate managers “bet” their firms
when they increased leverage in the face of
declining profitability. They raised the stakes
by issuing foreign currency denominated debt.
"The Asian Bet" by Campbell R.
Harvey and Andrew H. Roper