Default risk and risk averse international investors

Transcription

1 Default risk and risk averse international investors By Sandra Lizarazo Journal of International Economics, 2013 Presented by Danilo Aristizabal June 14, 2017 Sandra Lizarazo Default risk and risk averse investors June 14, / 14

2 Outline 1 Introduction 2 Model 3 Quantitative analysis 4 Results 5 Conclusion Sandra Lizarazo Default risk and risk averse investors June 14, / 14

3 Introduction There is a strong correlation between domestic fundamentals of emerging economies and their access to international credit markets. However, investor s characteristics... Develop an endogenous default risk model for small open economies that interact with risk averse international investors. Explain a larger proportion and volatility of the spread between sovereign bonds and riskless assets than the standard model with risk neutral investors. The risk premium in the asset prices of sovereign countries can be decomposed into two components: a base premium q RN, and an excess premium ζ RA (b, y, W ). Sandra Lizarazo Default risk and risk averse investors June 14, / 14

4 Stylized facts Emerging economies estimated default probabilities do not account for all the spreads in their sovereign bonds. The risk premium is higher for riskier countries. Investors financial performance and their net foreign asset position in emerging economies are positively correlated. Emerging economies credit spreads are positively correlated with spreads of corporate junk bonds from developed countries (Longstaff, 2011). Sandra Lizarazo Default risk and risk averse investors June 14, / 14

5 Model I Emerging country Preferences E 0 β t u(c t ) t=0 u(c t ) = c1 γ t 1 γ Income is non-storable and follows a Markov process with transition f (y y). If the government chooses to repay, resource constraint c = y q(b, y, W )b + b If the government chooses to default, resource constraint c = y def where y def = h(y) Sandra Lizarazo Default risk and risk averse investors June 14, / 14

6 Model II Government. Given the option of default, V 0 (b, y, W ) satisfies: V 0 (b, y, W ) = max{v R (b, y, W ), V D (b, y, W )} If the government default, the value of default is: V D (b, y, W ) = u(y def ) + β [θv 0 (0, y, W ) + (1 θ)v D (0, y, W )]f (y, y )dy y If the government repays: V R (b, y, W ) = max {b } {u(y q(b, y, W )b + b) + β d = { 1 if V R (s) > V D (s) 0 otherwise Equilibrium default set: δ(b, s) = 1 E{d (b, s)} y V 0 (b, y, W )f (y, y )dy } (1) Sandra Lizarazo Default risk and risk averse investors June 14, / 14

7 Model III International investors. There is a representative risk averse investor Preferences E 0 βl t v(cl t ) t=0 v(c L ) = (cl ) 1 γ 1 γ The representative investor is endowed with some initial wealth W 0, and receives an exogenous income X. If the government does NOT default: c L,ndef = X + W q f ϑ TB qϑ If the government does default: LOM: W = d ϑ + ϑ TB c L,def = X + ϑ TB q f ϑ TB Sandra Lizarazo Default risk and risk averse investors June 14, / 14

8 Model IV International investors VL 0 (s): value function of the representative investor. { VL 0 (s) = VL R (s) if d = 1 VL D(s) if d = 0 (2) V D L (s) = max {v(x + ϑ TB q f ϑ TB ) ϑ TB + β [θvl 0 (0, y, W ) + (1 θ)vl D (0, y, W )]f (y, y )dy} y and, V R L (s) = max ϑ,ϑ TB {v(x + W q f ϑ TB qϑ ) + β L VL y 0 (s )f (y, y )dy } Sandra Lizarazo Default risk and risk averse investors June 14, / 14

9 Model V The representative investor faces W < 0 that prevents Ponzi schemes. W W. Additionally, the investor asset position in bonds of the emerging economy is non-negative, i.e. ϑ 0. From FOC where q RN = q f (1 δ). q = β L v cl(c L )d y v c L(c L ) f (y, y )dy = β L Cov(v c L(c L ), d ) v c L(c L ) = ζ RA + q RN + q RN Sandra Lizarazo Default risk and risk averse investors June 14, / 14

10 Recursive Equilibrium It is defined as a set of policy functions for (i) the emerging economy s consumption c(s), (ii) government asset holdings b (s), (iii) the government s default decisions d(s) and default sets D(b W ), (iv) the representative investor s consumption c L (s), (v) representative investor s holdings ϑ (s) and ϑ TB (s), and (vii) the emerging economy s bond price function q(b, s) such that: Given q(b, s) and the investor s policies, c(s), b (s), d(s) solve the problem of the emerging economy. Given q(b, s) and the government s policies, c L (s), ϑ (s), and ϑ TB solves the problem of the representative investor. Given q(b, s), markets for the emerging economy s bonds clear: b (s) = ϑ (s) if b (s) < 0 0 = ϑ (s) if b (s) 0. Sandra Lizarazo Default risk and risk averse investors June 14, / 14

11 Quantitative analysis Data. Argentina debt crisis. Quarterly frequency data 1983:Q1-2001:Q4. Most of the parameters for the emerging economy are taken from the calibration of Arellano (2008). GDP is assumed to follow a log-normal AR(1) process: log(y t ) = ρlog(y t 1 ) + ɛ y and E[ɛ y ] = 0, E[ɛ y 2 ] = σ 2 y There is an asymmetrical function for output loss: { ŷ if y > ŷ φ(y) = y if y ŷ (3) Sandra Lizarazo Default risk and risk averse investors June 14, / 14

12 Calibration Data. Argentina debt crisis. Quarterly frequency data 1983:Q1-2001:Q4. Sandra Lizarazo Default risk and risk averse investors June 14, / 14

13 Business cycle statistics: the model and the data Sandra Lizarazo Default risk and risk averse investors June 14, / 14

14 Conclusion The model quantitatively characterizes the role of international investor s characteristics in the determination of SOE s optimal plans. The model accounts better for the sovereign spreads levels and its volatility. Including risk averse investors does not help at explaining the high levels of debt observed in the data. Sandra Lizarazo Default risk and risk averse investors June 14, / 14