15th World Congress of the International
Economic Association
Sovereign Debt Crises through the
Prism of Primary Bond Market
Sebastian Nieto Parra
Sciences Po Paris, Chaire Finances Internationales
OECD Development Centre
 Istanbul, June 2008
1
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 :
Governments
Investment banks/lead managers
Investors
•
It concerns the advantage of information that investment
banks may have over investors.
2
Motivation
Structure of the Prices in the Sovereign Bond Market
Pt  fee
Governments
Investment
Banks
PT
PT t 
C ( PT t  )
Pt  C ( Pt )
Where:
T:
Maturity date
t:
Issue date
C:
Commission paid by investors to Investment banks
P:
Price of the sovereign bond (Financial transaction that
Investors
it is the counterparty of the transfer of the security).
fee : Underwriting spread paid by governments to investment banks
3
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 the
Sovereign 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)
4
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 structure
of the primary bond market.
Information problems for the recent sovereign debt crises.
5
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).
6
Description of the data
• Period: 1993-2006
• Frequency: Annual
• 29 Countries: EMBI Index (JP Morgan) and countries
for whom we have information on underwriting fee
Argentina, 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)
(iii)
(iv)
Coupon rate is not float
Currency denomination (EUR, JPY,
USD)
No guarantee for the issue
7
Description of the data
427 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 market
we collect the major investment banks’ publications
published by the most important financial actors in
emerging countries.
8
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) , OR
2. 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).
9
Sovereign Debt Crises
SOVEREIGN DEBT CRISES
DEFAULT (S&P's definition)
IMF large package
Sovereign Risk Countries
Pre-emptive
Post default
Public Bonds
Vulnerabilities (PBV)
No PBV
Ukraine (Sept. 1998)*
Russia (August 1998)*
Mexico (Feb 1995)*
Indonesia (Nov. 1997)*
Pakistan (Jan. 1999)
Ecuador (Sept. 1999)
Brazil (Dec. 1998)*
Thailand (Aug.1997)*
Uruguay (May 2003)*
Argentina (Nov. 2001)*
Turkey (Dec. 2000)*
Dom. Rep. (Feb. 2005)*
Brazil (August 2001)
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.
10
Hypothesis
Efficiency 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.
11
Hypothesis
Efficiency 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.
12
Stylized Facts
Fees and Sovereign Bond Spreads during Crises
(Annual Basis)
Fee vs. Primary Sovereign Bond Spread
(T is the crisis entry)
Fee Average (%)
Fee vs. Secondary Sovereign Bond Spread
(T is the crisis entry)
Fee Average (%)
Secondary Sovereign Bond
Spread Average (bp; rhs)
Primary Sovereign Bond
Spread Average (bp; rhs)
1,2
1,2
1800
600
1,1
1,1
550
1
1600
1
1400
0,9
0,9
500
0,8
0,7
450
0,8
1200
0,7
1000
0,6
0,6
400
0,5
0,4
350
0,5
800
0,4
600
0,3
0,3
0,2
300
T-3
T-2
T-1
Source: The author based on Dealogic, 2007
T
T+1
T+2
T+3
0,2
400
T-3
T-2
T-1
T
T+1
T+2
T+3
Source: The author based on Dealogic and Datasteram, 2007
13
Stylized Facts
Fees and Sovereign Bond Spreads
during different types of Crises
Fee vs. Sovereign Bond Spreads
Pre-emptive and IMF Package No Public Bonds Vul.
Fee Average (%)
Cases (T is the crisis entry)
Fee vs. Sovereign Bond Spreads
Post default and IMF Package Public Bonds Vul. cases
(T is the crisis entry)
Fee Average (%)
1,8
1,8
1900
1,6
Primary Sovereign Bond
Spread Average (bp; rhs)
1,4
Secondary Sovereign Bond
Spread Average (bp; rhs)
1700
1,4
1500
1,2
1300
1
1100
0,8
0,6
900
0,6
0,4
700
0,4
0,2
500
0,2
300
0
1,2
1
0,8
0
T-3
T-2
T-1
T
T+1
T+2
Source: The author based on Dealogic and Datasteram, 2007
Sovereign Risk Countries
T+3
1500
Primary Sovereign Bond
Spread Average (bp; rhs)
1,6
Secondary Sovereign Bond
Spread Average (bp; rhs)
1300
1100
900
700
500
300
100
-100
T-3
T-2
T-1
T
T+1
T+2
T+3
Source: The author based on Dealogic and Datasteram, 2007
No Sovereign Risk Countries
14
Stylized Facts
Underwriting and Primary Sovereign Bond Spreads
1993-2006 (Annual basis)
Fee (%)
1,8
B ra zil( T - 1)
T urk e y( T - 3 )
1,6
A rg.( T - 3 )
1,4
A rg.( T - 2 )
A rg.( T - 1)
1,2
P hilip.
Urug.
1
0,8
0,6
0,4
0,2
China
A rg.
Rus.
R us .( T - 1)
R us .( T - 2 )
Turkey
Leb.
Leb.
Leb.
Ven.
Co l.
T urk e y( T - 1)
A rg.
Co
Urug.
l. S.A frica Urug. El Sal.
M ex. P an.
P hilip.
PAhilip.
rg.
Ven.
A rg.
Turkey
P an.
T urk e y( T - 2 )
M e x.(
T -2)
P oHung.
l.
Co
Urug.
l. Leb.
Turkey
MTurkey
ex. P hilip.
M ex.
Co l.
Co l.
MLeb.
ex.
Leb.
Urug.
P ak.
P an.
Ecu.
B razil
S.A frica
B razil
Thai.
Ind.
Viet. Co l.
P an.
Ven.
China P oUrug.
l.
A rg.
M ex.
Ven.
Urug.
P
S.A
an.frica
A
rg.
P razil
B
eru
M ex. B ul.
B ul.
B razil
M ex.
Urug.
M al.
P an.
S.AS.A
frica
fricaB ra zil( T - 2S.A
) fricaEl Sal.
Do
Com.Rep.
l.B razil
Uk.
China
M ex.
ChinaEgypt Leb.
P an.
Urug.
P hilip.
El Sal.
Co
l.
M
ex.
Leb.
China
M al.
P an.
China
P oChina
l.
Chile
M o r.
M al.
M o r.Chile
Co l.
China
Co l.
M ex.
P an. B razil
Urug.
P ak.
B razil
PChina
o l.
Chile
P eru
P
hilip.
Hung.Chile S.AP
frica
o l. S.A frica
P eru
P eru
Hung.
Urug.
El
Sal.
Thai. P
o l.
M ex.
Turkey
China
Ind.
Hung.
P o l.P o l.
Turkey
Ind.
P hilip.
Turkey
P hilip.
Leb.
Hung.
Hung.
P hilip.
Leb.
P hilip.
Ven.
Co l.
B razil
Ven.
Turkey
Turkey
Co l.
Ven.
Turkey
B razil
0
0
100
200
300
400
500
600
700
800
900
Primary Bond Spread (bp.)
15
Econometric analysis
feeit  1   2  SBS it  3  crisis it   4  SBScrisis it  5  Ti   it
where
feeit is the underwriting spread received by investment banks from country i in
period t,
SBS it is the sovereign bond spread (i.e., primary or secondary bond spreads) and it
is taken in basis points (bp)
crisis it 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.
SBScrisis it is defined as the product of SBS and crisis
Ti is a time dummy variable.
OLS and Fixed Time Effect estimation
16
Econometric analysis
Undewriting Fee, Primary Sovereign Bond Spread and Soveregn Debt Crisis
(1993 - 2006) Annual Data
Dependent variable: Fee
I
Primary Sovereign Bond Spread (SBS )
Sovereign Debt Crises (crisis )
No Public Bond Difficulties (crisis )
Public Bond Difficulties (crisis )
Public Bond Difficulties and Currency crises (crisis )
Interactive dummy (SBScrisis )
Cons
N (Observations)
II
III
IV
V
VI
VII
VIII
IX
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)
0.35750*** 0.52239***
(5.25)
(2.78)
0.01504
0.23692
(0.10)
(0.75)
0.44217*** 0.94235***
(5.92)
(3.83)
0.57120*** 0.75583***
(6.92)
(2.86)
- 0.00043
- 0.00083
- 0.00121**
- 0.00048
(-0.94)
(-0.80)
(2.13)
(-0.74)
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)
170
170
Adjusted R-squared
0.0345
0.1665
t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.
170
170
170
170
170
170
170
0.1659
0.0288
0.0267
0.1974
0.2141
0.2449
0.2429
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).
17
Econometric analysis
Undewriting Fee, Primary Sovereign Bond Spread and Soveregn Debt Crisis
(1993 - 2006) Annual Data
Dependent variable: Fee
I
Primary Sovereign Bond Spread (SBS )
Sovereign Debt Crises (crisis )
No Public Bond Difficulties (crisis )
Public Bond Difficulties (crisis )
Public Bond Difficulties and Currency crises (crisis )
Interactive dummy (SBScrisis )
Year 1994 (T )
Year 1995 (T )
Year 1996 (T )
Year 1997 (T )
Year 1998 (T )
Year 1999 (T )
Year 2000 (T )
Year 2001 (T )
Year 2002 (T )
Year 2003 (T )
Year 2004 (T )
Year 2005 (T )
Year 2006 (T )
Cons
N (Observations)
II
III
IV
V
VI
VII
VIII
0.000432*** 0.00039*** 0.000409*** 0.000432*** 0.000434*** 0.000363*** 0.000391*** 0.00037**
(4.80)
(4.43)
(4.52)
(4.76)
(4.75)
(4.12)
(4.43)
(4.53)
0.16648*** 0.27861***
(3.41)
(2.07)
-0.00047
0.04411
(-0.00)
(0.21)
0.21430*** 0.55234***
(3.92)
(3.09)
0.35271***
(6.14)
- 0.00029
- 0.000167
- 0.00082**
(-0.90)
(-0.24)
(-1.99)
-0.9252
-0.07063
-0.06250
-0.09253
-0.09244
-0.06503
-0.03976
-0.04496
(-0.90)
(-0.71)
(-0.62)
(-0.90)
(-0.89)
(-0.66)
(-0.40)
(-0.48)
0.05713
0.07884
0.08710
0.05713
0.05723
0.08433
0.10972
0.10443
(0.51)
(0.72)
(0.79)
(0.51)
(0.50)
(0.78)
(1.02)
(1.03)
-0.04233
-0.06515
-0.06891
-0.04230
-0.04477
-0.05266
-0.04397
-0.05786
(-0.45)
(-0.72)
(-0.76)
(-0.45)
(-0.47)
(-0.59)
(-0.50)
(-0.69)
0.12083
0.09848
0.10391
0.12082
0.12091
0.09144
0.10221
0.09809
(1.37)
(1.15)
(1.21)
(1.37)
(1.36)
(1.08)
(1.22)
(1.24)
-0.08482
-0.09683
-0.08744
-0.08482
-0.08509
-0.09817
-0.07146
-0.08453
(-0.92)
(-1.08)
(-0.97)
(-0.92)
(-0.92)
(-1.11)
(-0.81)
(-1.02)
-0.19399** -0.19972** -0.18354** -0.1940** -0.19417**
-0.20**
-0.15432** -0.18498**
(-2.19)
(-2.33)
(-2.10)
(-2.19)
(-2.18)
(-2.36)
(-1.78)
(-2.33)
-0.18536** -0.19484** -0.18598** -0.18533** -0.18568** -0.18138** -0.14753** -0.15657**
(-2.08)
(-2.26)
(-2.14)
(-2.06)
(-2.06)
(-2.12)
(-1.71)
(-1.95)
-0.39163*** -0.37188*** -0.36895*** -0.39160*** -0.39221*** -0.35394*** -0.33286*** -0.33485***
(-4.61)
(-4.51)
(-4.47)
(-4.58)
(-4.57)
(-4.32)
(-4.07)
(-4.35)
-0.39932*** -0.38363*** -0.37610*** -0.39928*** -0.39633*** -0.35917*** -0.33910*** -0.34031***
(-4.32)
(-4.29)
(-4.18)
(-4.29)
(-4.21)
(-4.04)
(-3.82)
(-4.07)
-0.52629*** -0.49944*** -0.49357*** -0.52630*** -0.52643*** -0.49063*** -0.46871*** -0.47134***
(-5.96)
(-5.82)
(-5.73)
(-5.94)
(-5.92)
(-5.77)
(-5.52)
(-5.90)
-0.55142*** -0.52708*** -0.52006*** -0.55142*** -0.55144*** -0.51988*** -0.49627*** -0.50020***
(-6.26)
(-6.16)
(-6.05)
(-6.24)
(-6.22)
(-6.14)
(-5.86)
(-6.28)
-0.55111*** -0.5280*** -0.52042*** -0.55111*** -0.55110*** -0.52160*** -0.49716*** -0.50172***
(-6.11)
(-6.03)
(-5.91)
(-6.09)
(-6.07)
(-6.02)
(-5.73)
(-6.16)
-0.57220*** -0.55153*** -0.54283*** -0.57220*** -0.57206*** -0.54671*** -0.52062*** -0.52645***
(-5.89)
(-5.85)
(-5.73)
(-5.87)
(-5.85)
(-5.87)
(-5.58)
(-6.00)
0.69821*** 0.68617*** 0.67354*** 0.69822*** 0.69767*** 0.68696*** 0.65501*** 0.66533***
(9.07)
(9.21)
(8.87)
(9.04)
(9.00)
(9.32)
(8.76)
(9.59)
170
170
Adjusted R-squared
0.5980
0.6238
t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.
IX
0.000369**
(4.47)
0.34053*
(1.84)
0.00003
(0.07)
-0.04580
(-0.49)
0.10360
(1.01)
-0.05822
(-0.69)
0.09776
(1.23)
-0.08567
(-1.01)
-0.18644**
(-2.26)
-0.15747*
(-1.93)
-0.33558***
(-4.31)
-0.34102***
(-4.04)
-0.47209***
(-5.84)
-0.50099***
(-6.21)
-0.50253***
(-6.08)
-0.52730***
(-5.94)
0.66631***
(9.38)
170
170
170
170
170
170
170
0.6234
0.5954
0.5929
0.6320
0.6390
0.6750
0.6729
18
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)
19
Fee and financial markets’
actors
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.
20
Fee and financial markets’
actors
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.
21
Conclusions
1. 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.
22