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An analysis of credit terms in the eurodollar market
Un:wrMty~f Cal~on~a, ~AeL,'~, CA 94720, USA l"~x:~:e.avcd (2~'~ot~..r 1976,fil~ulve.~ ,~re~er.~dIV~.-u-ch1977 ,%. nlod~ a'; pres~nt~:d ~ n c ~ o r a ~ g VzkmO~ dC'V.~ taso~ved /n t ~ d~./.l:,~a~n-tclon of the :n~cJ'e,~mzm ,n = ~t.'d ~ r ' ~ fi'm~:~.'~not p ~xclycm~mpctatx,,,cIt~e~dz ~ r.~udlbr~'~ ,'~2al$on b:twe.cn the mt.;m~r.~t~ c and th~ probabxh~ of d ~ u R su=h tlm~ higher ~mbahdr~ *rn~h~ h "~ker in~r.s~ O~.he~ fae~ar~ ~.¢f~,,mg~e r~tc c,f,nt~.r~tare ~h¢ ela~uc~tyof demand, th= D'eree:,~l raze of |ores rc|a~ed (to defau|~ m~fl an c~'a pren~zunl dl~~. tO t~k m,terson The cqudlbnum rcLat~onLSused aS an c c ~ m m ~ c model ~ h , ~ , under z pp**'op~tc speeaez.~t~om, 5"enerc:,~-s~ a a t ~,, of ~hm we~',h~ at~¢he~l to su~ecttve x'~k m d.~a',or's T~: d ~ ~rvcr transo.c~JOnSm tl~ Etnocurte.~cymarka and de~|only w~t~l~ubl-~.~y,~arancecdle.mnzto 4o.clop:ng co,tm~nt~.Sevcr~ cconoa'~cz~td~catorsR,-czdcmaficda~ s ~ t ~ V affecting t~.'~subjec~ve p=ohT~b'dg.y.~ cam I~ Ux'~ to 8~a~-a.~c ~ttmates ~ I~e s u b j ~ v o ~robal,lh~ t]he~m.r~/ves.
tr~s2u~en "Uaexe is ~ o d o u b t ~,h~t 1~: p t u b a b i l ~ y o f ~ - ~ a ~ t m i n t e n ~ o ~ b o r m w l n g is ~ ~o ~ e eco n o mic d ~ t e r ~ m ~ , of ~ebt.~ervieing ~ p a c a t y (DSC) ~md that !endcrs ~:r~ g~.=fiy e o , ~ = ~ d w~lh th= v.zm~e of d~= llnk. A Iog~c~ Lm{ l~eafion of ~ S f ~ ~S th.'t~I~I~tfflT2.Sof cred.~ cx1~gRd,~ ~0 Varloss bOrl~3Wct~ (as f-.ga"as ~=r'/r~, ~ : de=~.5~cn v ~ b | ~ on the p=z~ o~ d ~ lend~r) are relentedto D S C as re2~r~'d din)ugh '~he probability o f de~hnlt, E~ -en, L'~ca.¢.~whs re th= te~m~ of :~ed:. ca=not be ~/ffer'~lda:ed (e.g., n~a-eor~zwr:/at mtc:nazional or~_n~zatic~, ~.t~ a y b~ L ~ ~.~ volume o f c n ~ - ~ l~ m~qi.~cn~d by t%~:probab~hty of /,:fatd~.T[t'aS, a ImLeW~Se of~hc ~'t[ons{f p 0f &.~na~nlut~ of D S C and the pzoba'b~l,y 9,[ dCi'O~L ~, o f ~r~e,r e ~ so£ 02.~l~,%0'lena~'.~ b ~ ~ds,):o oorrowers,
,~rcd.~ ~, c ~ ~L~ d~:i*a:, Z,~twc~n !937 : ~ t ~974, the ~-..r: o~ p~vate cre'.h~ors
3~22
,
G, .Fcde~" a n d
R,~, d#2;t,~MwralyMaof credit terat~
m g ~untries. While in 1974 Icss-dcvelopod countries (LDC) accoun~xl fo~ a ~hird of publlcizod Eurocurrency ¢;edits, 58 l~rc~n`tof publlcizcd ~ran~ct~ons h~ ~ fast half of 1975 involved dcvelopiUg countries. Th~ purpose of this paper is to inv~t~g~te the rclatioRship of D$C, the probability of d~fault, and the terms o~"credit obtained by devcioplng ~ountrics m the Eurodollar mark*t. Fir~, a tlm~)redtml model is c o n s t t ~ e d which desc~~bcs lenders' detarmmataon of credit:tt~rms in a framework of monopohst~c o)mpctitaon.The theoreticalmod~l ymlds an equihb~um cand~uon which demonstmtcs the rcla~onship of d~'aul`tyrobabfllltyand the tcrms of credit El:tsttcaty of loan demand, th~ pcr~ve.d ram ,~)f~oss in the event of dcfault,and r~skavers]on arc other f~tors whcb apparently eu~r the v~qat~,0nstup Reprc.,,~nllmg the probabihty of default as n funodon o~ DSC ~m~ica~ors .~n the log]t form [Theil (1970)], it becom~ posslbte to eoonometnc:flly estimate the ~s~l~ng equdibrmm r~hfioasl~p. TI~ model is thus apphed `to the E~rodollar m~rket to investigate "the empirical important: of various D S C d,-~t~inants and tmrceived default probaMhty in detlerrmrJng m~ez~st rates. 2. A med¢l of ]e~ers' d e c ~ o n - ~ , ~ g ~ ~ : Eurocu~c~cy ~ r k ~ Lending prattles in the: Earoenrren~; ~ r k e t differ from h-*,dltiomal banking procedures i~ several respects. 2 Th~ rote ofimcreslt in Euro~urrcncy transat~iens ;~ composed of two dements. (I) tho Lnterbank x'xte of interest and (2) th~ iu~res`t margin "lhe intcrbank rate of intetcst-wmatly tefcrr*t~d to as the 'Lcmdon Interbard~ Offer' (LIBO) rate - zs th~ th~e,-month or (slx-month) dcposli rote. Almost all transactmn~ allow th¢~ LESO rr~t~ to flo~t as a ~ . s u r e of prot~tion Io the lender, a~ud the MBO --ate is iv general tim s'~m~ for all borrowers. ~ Tim interest 'margin'-also refer,~cd *o ~s the ' s p r e a d ' - i s ~ fixed rate of mteres`t char~ed m addition to the LI]30 rote. I' daters from '~ra,nsac*don to, transaction and reflects both the credit worfltin~ss ~f `the bo,:rower and ~ e Io~n duration.The margin ~sobvaously associated w~th ~ pro~: margin of~Itebanl~, s m ~ ~ L!~O rate is cle~ly r~latcd `to t ~ cast o "eapit~ to ~a~ ba.,d~. Typ~e23Jy, a Euroloaa is '~danted in *2to form ~,f r~woXvmg credit, Le, as a short-term a~Jvem~ which has t.obo r~n¢~md ev,~ six montb~ for *.~ duradua of the comuntmen~ period (whie,h may so~t~m ~s be ~,, ion~ a'~ _*$ y~:~) Th~s procedure oft~n l~ads to a °ba~loo~' lbrm o ripay~)en`t 0.e., r~:paym~:nt m one iasts]Imeu~:;~t*he end of*.hecomzcd~2nen`tp*n.)d). , ~A com~IgL~~md m.x'h lx~t-~l l ~ h y ~ c a ~ a t oi t ~ mcdJ¢l~ ,l~VC~zn FC~.~,tand J,~ (vnoO.
G. FaCe..-'~,P..~ J ~ , ,.~ ,r,a'b'~ ofe~dl~ t~,~,
223
Most of ~tc lending in Euro~.u~en~ m donne by syndicates of baul~ or by consoz~t banks aflbrdzng a much ~.~tcr d ~ b u ~ o n or n s ~ U s ~ l y one b~nk serve~ as u m~na~er Goad bm~) and eonducls the negobauons w n h the !~7ospccfive borrowe.r 'A comprehensive evalua.~on of ask is m)rmal]ly mndc by th~ lead hank 'with p~t~cJpanz banl~s relying almost cxcluszve~y on the infornm~on prodded by ~ c lead b ~ L °'~~lut there ~u"eu number of factors which produce d~'~renUebon betw~m b ~ s both wltbm the n~rl~:t ~id wi~ rcspcc~ to o~Jer finavdal msutuUons. For cx.~oplc, b n ~ s &fief in theiramtudes toward ask because o'Jd~fferen¢s~zcs or dd~ercnt prcfenmc~. Also, mlbrn~uon on cretin m~vas~s hm~:d (at least danng the negot~auou process) sine: neb'ouatton~ are ~cpt secret; and, b;tn~.Smay offerd~ffcrc~t opUons with re~,ec~, tO the c arrency tO be used at ",.hetJme o~ repaymc~t Thus, the Eurocurrcncy marke! appears to be a c~c of monopolistic comI)eUUOn [Cohen ~ d Cyer~ 0955, pp 207-225)]. Accor&ngly, whvn d,:~hng ~qth a poten~al borrower, the bank (Dr the Ic.~i~ngbank) fac~ a dog.award qlowng ice,dual demand c~rvc. The residual dcr~mnd is determlocd, by tl~e o~er,d| demand of the borrower for cx~crnal r~sou~ccs as wc'.'ias by ~tsrnauve sources of supply. 3"~'.se alt~rnaUve s o u ~ , include other financial m,~'kets, bonds, o~her banks m the Eurommkel, th..country's own x~ou~cs (in t~: =~s~ of a govcmm~.~at), etc. W h e n nego~athtg with a polcnt~d hor~o,~er on a possible loan, the ban}: is aware of the possthflhy that t ~ |o,m ~nd m',~es~: wil~ GOt be fully l ~ d if the borrower does not (or c~mot) meet obl~t~oas N~rJon~J defaults (in the sco,,c of tmw~11~n~ncss or ~n~bd~ty on the part of governments to honor con'tractu,d obli~fion~ to f o m ~ creditors) I~v¢ occurr~ in s number of d~eloping countries since World W~,~ ~]~ U a l ~ the p~war era, it has beer~ common for the c~ed~tors and the debtor ~o work a rcsch~duling or refunding that provides for delays ~a debt service,reduced m t c ~ t rate.a spreading of maturates, ~md/or elimination of part of the loan ~ Such arr~cmcnLs are advan~eous for creditors b~c~use they ¢ o u m ~ the bo~ower ~o at least a pazt~M rcl:~yment ~ d also for deb~o~'~ b ~ u s e the nec~ for lordly ~.~mnouncmg default Is chmlmttcd ~-~evcr, ~.hedebtor's advantat'e ~ay be marc ps~chologzcal ~ d pohui~l than ccouo~o d~c~ ~ Myr~L~ (1970, pp. 291 and 292) cor~nen~, such e~raogc : ~ t ~ C¢C ~ J b ~ bV~ 'r,more cof~sidcra,'eway of ,'Itm'~a~nga ba nknup tc~" tn rues: of th~.~"cs;mct~,~h~ cr~F.om incur some loss e~ther because payments ~ e dc~,~tyccl~ d th,=r valse is reduced duc ~o inflation or because there ~s ~tcs~u:~ ~o sol~n L ~ i C ~ o~'crecEq or ~o write off par~ ~f L~C debt In vdd~uon ~r~t~or~ c~)~ ~ ~r~cur~C~n ~ ~rocc~s of rc-~cgot~Jon. A ,~sk ~ u a t a o u
and tim loss that may be ~uff, t~fl ~a' the event ,of de~autt.',Saeh an em,thmtioa obvio~|y focuses on t.he eeo=cmti>¢hare.eter~l~ o~' ' ~ country as a ~,~Jlo~ ( ~ ~ e.~e o~ pubh~ or pub~ciy gtmrante.ed k~ans) ~ c e ~ h ~ are *.he d ~ r m~nants of D SO.~ It ~ s~m~ ~easo~b~ ~a~ ~h, pmows o f risk ~l~afio~, provides "~ae bank with so~a~ (subjeofivg0 nofibn o~"fl~ ~robab~ti*y of d~t~aull~, F~rt~rmore, if b a ~ s are ¢~nc~me~dwJ*dzthe ~mW.o f l o ~ ~.h0.~isin~a~m~f-fol~ow. ~ g a default, then :z s u b j ~ v u L'~obabi]ity- s~.y, W(~)- :i~l~I~.~ f o r m ~ fo:r loss rate h, g~*en ~ae the full term~ of the agr~.~mrmt~ ¢ no~ m¢~(Lu., g~ve~*.~l default occur), t~or .no=tJonM parpos~,, let *dxeraudom wat~i~b~h be eo=*~2iued in the rang~ Lh, X], where h = 1 Jmpge~ ~. complem ~o~s ~ld ~ ~ ~!hem ~ h ~ t expected zam oflo~s; h~ce,
It is re~nab~e eo ~ssumo thz~ 0 < h dne~ countries wi~lLavoid clda,u~ (or reschedohng) ~f flae dullest is r~lafively smML W21ea default does not occur (which has probability ~i-2~(X)~, ~,~ ba~k receives ~t~net Icveaue oJ~r-L(r) e~teh Nero'throughoa*. ~he d umtJoa of the• loan where • ~isthe inteze.st nlargm ~md L is Lhe slZ¢ of ~*. ]oar*~~ The slz~ oJ"loan
demanded obv~o~ly dal~ends o~i wbc~'tthe ;borrower ex!p~.m'regatdiu~tlm beba,~ot oftk¢ L ~ O ra~e during t~u pc]dad of ~repaymc~t, b~tt thls is ~Jvetze.r.ogenouMy for ~Ja¢bank. Honor, reddtm] dema~.d re!: l c o ~ h; reprcse~.*ed, only as a faacfic-_ of ¢he,margin ~ , L I~ Z.~r);
aLlOt = L, < O.
(2)
Suppose Lh~:st~'a~ o~xlet r~.'~.'~es "isdiscounted bee..u~,~of~he c~¢ ol eaplml to the bank. "Ihe oust of e,apiWJ(wl~clx i~sre!,',t~d *o~.he L ~ O ~'.a@is =~>~~r.~w= a priori for ~,heend:re d~wa~o= 02 the ~o;m, b~.~~ ~. ~t~0on~i.,~)zo as,~mz ~x:~ th~ bank l~; ~ome ~e~ghred no~on ¢~? t];e cc~ o7 ~k~taX ( ~'~',r*) tXL~.tmt'.y prevai! u~td tim le~t ma ,~res b~:,ed o~ cx~$n*-n~* ~:~d r&xF~t:~Ja:~.USU~ X2~A~
]~t'¢clvcd r~¢ to d~SC01,~R¢tI~ net rcvcntl¢~s,3n¢ obt~ns
= rL (Ill
-(l +r+)-~/r *)
= rLO,
(3)
whcNl~
and A' .'sth= comrmLm.cm period or Io,'u~dumuou. In +he case of a syud~c*~tcd ~oan, one may coamder e. fr~ct~on of the I~oa.u(=L) w;thout clu'mt,'~ug rd~c mendel as long as ~ is prc~ctcrafined. For Lhc purposes of th~ paper, ~t ~s ~sum."d 1~,t ~¢ bon'owcr s Cl~l crccht fo~ a L~Ven duraL,or, hence. N i~sd¢¢,c'rrmncdLcxo*jcnously ~or the lender. Suppo~.~ tha~ th~ bank Iresa u~hty f~mction defined on nct d~c~)untc,i fcvenuc
u=u(a9, u'>o, u"~o,
(4)
~nsimplying rhk a~c~on or risk ~ev~rnIRy.C.~venth.~s~Umfionof ~n~nmV/, it Ls ~s'am~d d~% ~ Icndcr's objcct~v¢ is to mm,drm~'c, ¢xpcc'~.~d ufiIiv: by o~tim~.tly choosln~ the in~t,~st margin r. Lc.,~
G. ¢~r~.'2R£.Jg,%,~nanal¥~ofoedltter~
The first-order eo~. i~iou fo~ maximization of (5) requires I° . . . . ~
( I - , ~,: ,~ .+L).v'(rOL~-PX.A~ h ~ ' ( ~ ) e ' { - ~ } ~ = o.
,'
(6)
From this cenditioa, an econometric r e h u o ~ h i p may be developed as follows• Rearraog~og ¢q• (6), one ohtalm #.
P tl ~-t
t"~ e ' { - h L } . h . ~'(h)~,'
[l--e~O 2~-
V'{rO~}
'
(7)
where ~/is the da.~iadty of demand t'or loans,
= I,L, ILI.
(8)
Sm¢¢ r should be non-negative and U' > 0, it follows dmt ~ > I at the poit~t of optimality. In order to summarize r.h¢ factors ~beting interc*t margin, it is useful to consider eq. (7) assuming, for slmphd~, that h talces only one value, ~, r=A"
~ '
Here the term, r//t~-1), rcfl¢:,'ts the b o r r o ~ ' s t~argainlng posNoa wNch deponds on alternative a s m ~ of supp'Jy and the overall demand of the bo~ower. The factor 0- ~ is a profi.mbiliD" pam~meter xelated to both the, discount rate and the duratton of the loan. The risk asp~* of loan maturi~ is h~'~judcdin ~ c term, P(JO/[1-P(X)], where N (loan dum,tion) ~s an elemcm in the X factor. Other economic indicators are also R',flect,¢~ht ~'.lasterm wh/eh is th'as t h e / ~ k betwc¢~ DSC (as perceived by the ~eradc~')and ~he *erms of credit. T'.,e ~ast term, U'(-ld~)f U'(rOL), represasts the ex~a fi,~ prenfium that is chargt¢l due to ri-d~:'averslo~ on the part oft'he lender. C~Vithr/sk ne~trMi~, th/~ term is identically equal to ~L,0a'gcr'*J~a~ X.) ' F ~ p~cm~m,, while uader ns]: .,,version, U " '< 0, it ~s a l ~ however, may be l~egt/#bi~/fthe voi,±~.~gt.~-'a ~.~sac~on (Le•, ~ vol~un~ of L or of the person e l l ~:~t ~'~~ d e r t ~ u by lhe, baak) i~ atoM1 gelafiea.to Lb2~ Another property of the ~ode~ w/M¢.h/s u,~,ffld ~ i n ~ z ~ , ' ~ ~-'~,~ae~¢~ ~esults with the medal ze,I~s t~ r h k n e ~ r ~ , ' ~ m d y , " i~- fl~e ~a.~ ef r~.~
6. FeA~ ard lLI£,l~,.da aad~x;aof cred;tr*nm
227
neutmlit'y(wlm~ the tlskaversionp ~ m i u m isunity),'d~ model in (7) zeduce.st~
r = ~=i-~Ti;-e'
(~0)
wher~
whether ~)r net lossra~chas a sm~al~ distributionas m (9) Hence, to the extent that Earom~-kct lenders arc risk neutral or indiC,dualtralnsact~or~sare small tx,latlvato totalwe'<d,econometric interprctalxonscan bc greatlyslanph~cd t~ Furffiermore, tht..'se coadil~ons inde~ seem plaustble m the Eurodollar markn~ bee~se of the sine of fi.sancmlmshtutmns mvo'~vcd and the extent to wbach loa~ may bc syndacatcdor chstnbutcd among b~mks.
3. An eco~me~'~c ~'m'm~,~J~en "I~ au~ysis of t~c previous ,~ct~on has p¢,stulate4 tha| the n~k of default is one o,~ tbe factors determining interest margin m Eurozm~rket transactions, Risk ;s vcprcsentcd by two components: (1) the probability of or=fault P(.I') aud (2) ~_be rate of Ioss h or its chstributton ~(h). The function F(X) may be rcgard.:xl as the lender"s st~bjectlve probabihty of default based on av~alable economic data for detea'mlnan'~ oF DSC. "i~nat is, th~ v ~ t o r X ss composed, ia addifioR to loan dmataon, of ¢¢ouomm, variables which a~'e considered by lenders as r~Icetmg DSC. Hence, while ob~rvatioRs oa subj,~tive probab~htics arc not c~vmlRble,~ on economic indictors e r a be used to estimate tee re~atlonshlp In (9). To do th~s, b o w e r , R is necessary to specify a functional ibrm for the ftmcti0a P(X'). Such a functional form should be boandcd between ~ r o ,~d o: ¢ for att values of X and should be sufti~c~tly 'flexible so :h~t P c~m ~tcrcase wP,h pas~Uve ;sk indtc~ttorsand decrcas~ wztE erccht-wo,rthmes~ ,~ndi~tors,,O ~ o~.*~;~emosi widely us:d spec~=~nans for probabilityfunctions wbSch s a ~ e s t,~es~~ £~tionsis tb~ logist~form [Cox (1970)],
i
w/ze~ ~'is the &=¢r~J~a o f . ~ U's~g'ads ~,'~icat~bn~ ~owever,one finds ~ a t the logarithm of odds is l~¢ar in the parametezs
and,/~n¢~, tiae structural equation in (9) may be writteu i~t logarithmic form as
+In
f(f'
L d~
v
?
k~(h)U'( -/',L)~tdh (U'(rOl'.)) . // J
(I1)
Turmng to the other ~ertr,z in the model, recall tla~ 0 de~ends o~ N (]oma dnratzoa) wi~eh is obse~w'~bl¢;tad r = (t~e per~jved avez~ge cost of eapitrd) which is not observable. Hexc one may postulate that r ) depends oa historical LIBO rates singe expectations are usually based on I)~st experience. In tbls context one might introd'tt¢~ a distributed lag r d a t i o J ~ p for r* or' simply postu~zt¢ that r * ~s an average,of past rates, For siraplJ,=ty it is assumed,in the empirical part of tbls paper that ,the e.~pecled,r* is the averar.¢,of LIBO rat~= in the 12-month period 9re~'Aing *.he~m~?etionY = Hentc. ~ 0 ~.r,omc~ observable and m ~ t simply be constrai~gd ~ ' ha~a a eoeffident of -,=L The elasticity of demaud for loans ¢a~not be observed; ~ , the te=~ rt/(~/-~1) is not known. S ~ th~ eba~icit~ is ~ u n ~ s;p~" e, the ~ltrod~fion o~u,country dummy vat/ablemalt sUffr~e,,But.~ clas~ei~ may also be r ~ i ~ e ~ ~y ~ = effects.For instance,when.supply ¢,o~dons in the Euromar[~etor.othermajor financialmarketsam changing,t~ r~i~..zd~emznds fa~mga d~!~ E~u~.)w.~d:ee lender w~]Iz~J be eh,2.aging,~n't~c sam~ dire.e~,on. ~V~o~ovcr, ~ f~r obgervairons relating to a glvea c o . t r y at a given p~n~,m tigr~, l~,r~ m:lly~ , d i [ ~ ¢ ~ m r/ff observ~,Sionsrepre~nt governr~.nt-Su~trame.'dloans ~,akenby ~ f f ¢ ~
appropri,atctO VJ~W]M/ff(~)--~)aS a ru~dclrnvar~,~b~e~coz'oorl~,*dngbo*d~t~r~.¢ and couatry st~'~fie eff.%-'tsaS well ,as au ~ff~: ~ ¢ 1 ~ to ~o y,'~.~L~'~'~lm~.s~' act=on cons~de~.,d. For empirical p-I'rgoses~'dt~sp,a!~:r com~, d ~ In [~,#l/(~,/-1)i~ = ,~+',r~'~+~,+'s#¢~
, ,
(12)
:~r~umpfion of random time ,-tad counta7 effects thus oorzesponds zo the va~&,t~mp~ appr¢~h which ~ bean ~ econometn~lly m the com~xt of oombhmg oross-.~-cO.onand ~ sen~ dam.,s's T]m lasttv~m ofeq. (II) is hal ob~rvabb but, ~ ~nchcatedabove, a may be ¢omidere~l minor in tho case whe~ ~ loan ts but a small fr~cuon of th~ bank's w©~m'th.~, this ~.se, one obtatm
where ]: a, E(h). ~'them is some small variation about In}~,it may be considered as yo.vtol t.heerr'ortern~with poss~ly sgveralcomponents defending oR tlme or transaafions L ~ z ~'~o(12). F o U o w m g the above chscu~ion the model m (II) ~an ~. rewrittenas L
Inr = ~ + ~
E(ub
~--ln~+~z~+v~+wu~.
= E(~,) = Z(w,,j)
= 0,
(13)
wh.'~c//~t -~/~o+#4-1a~/ The model now appca~s ia th~ familiar erroz compo~ants J~orm [Wallao~ and Hus~dn (1969)].Assuming that
and that E ( ~ ) = a., ~ ) ~- ¢¢, und E0~.~) = ¢z~,for all ~,A and t, it is thus passe,hie t~ estimate ~ , ]l~. . . . . ~ covaist~ntly and asymptotically efficiently Isle I.~ctl,ov~(t971) an6 Maddala ~,~dMount (I973) for an evaluation of Winoa,, al~,'ra~fi¢c esfi~na~ors]~ Farthe~ote, :~ is po:,s:'bIe to ¢stmaate ~,, %, and ~,,, ¢'o~;~/gufly so that some infor~mt~on oa the importun~ of vari~tzon m demand cl~!~d~' and risk prdbmn~s ~an be obl~aed.
To cSdm~tc t.he zaOdCl ~ ~,13), h • ~ s a r y to de.frame the~ xj factors w'hieh ~osKvly after: lender' Tmbj~dve cvatuat~an of de.fault probab~Jtty A~ ~ d L ~ ea~E~~, ~evu~z~x1loaa du~fi~n ~ one ~anabk' wb.~chshon~fi be ¢~Jns:deJ~'~ ~.'l ~ X v~"cor. ~=[ vbv:ot~s|y magy other factors .~|so affezt the pl,ob~o~ihty Of d~f~uI~i(or DSC), Many s,~eh economic f~e~o~ h a ~ been dis ~ C d ~ : ~ r (t961)~F~-~:ch(i951),.~iY~ell(~9G2),Cm~2m~a(1957), Bxtt~mann
230
, :
6.F#d#rand~.E.J~¢,
~n~l.V~:ofcredl~ta~:
0,973), and'Avramovic¢t aL (1964): F~rtherr~or¢, an objective and quantitative m~dy of default prohabllit/es b y F~mk ~nd Ciifie (1971)~has also indicated the s~.fistical imponano~ of a number ot L ~ o "¢ariablcs. Thas, the results o f ~lis study serve to reveal tb~ ~ t,:ntto wlnch lenders actually consider all of the ~-'tors affecting DSC in practice. N'me economic mdicatom ~re used in the analysis of whidt seven are the same as thosL used by Frank and Cline (1971). The ~Ldables are defined as much as possible l~e the ,,nes used by Frank and Cfiue to facilitat~ ~,ompzrabi~Ry of results, hence, only a brief desenption of most of the indicators ot DSC is required here The measure of non-compressible ~mports used in the prenous study, however, is not indu&.'d because the da~t for co/clfiating at wcrc not comparable ,among countries tbr aJl of 1he yea~ used and because thcoreucal arguments have been dcvelol~ which quahfy this indicator. The usual argument is that im,orfs of various consumption goods, which are not ~tal ne~ssllaes, can be c~ai~ed tcmpo~zdy so as to increase av~labihty of foreign exchange for debt ,,erectingpurposes. Tim assessment of this,factorthus rccluircs detailed data on/report composition pRttcras Morco'~er, them' may be raw materials ariam~rmcd/a~e goods that are imported for p~oducfion of demesne nonessential goods which can be reduced, hut sepamtlon of these from other intcrmedmte goods zs ns~,~ "y ~mposs~iblo Furthermore, possibihfies for mducin~¢ anpoc, s may depend hcawly cm a gove~nmeat"s internalpoliticalstatus rather than on the economic.~mporh~nce of import items. Thus, ~t seems that the notion of compressible imports may be of littleemp~rlcaluse untilareasonable approach for incledmg politicalstatus is d¢velo]~ed.a,# in the short run, debt servicing ~l~icuI~es manifest themselves as a balance-ofpayments crisis. Thus, short.zun'DSC may be studled by analyz~g the various elements of th~ bala,'~o~of payments [Avramovioetal. (1964, p. 13)].Tim most cotm~on mdlcator is 'dan debtlservic6 ratio, i.e~, tha m a d of debt service ~o export~ [Frank and Cline (1971)]. Supposedly, a h/gh ratio (indlcafing a l~cavy burden on the county's researccs) is ,zerOed'to a higher risk of'default.Irvh~e e~ al (1970) have also suggc~tcd, however, that capital inflows should b:. taken mW ~eco~nt m the shor~ run. At~hdugh uhas variable Was not consld~d emp~co21y an the Frank and C~ine study (1971), capital flows in the form of loans, gr~n~s,d~rcctinvestment% and ~mns fc:rl:,ayments'a~ nn impo~'~ut souz~ of foreign c~chaage recdl~s v~bach can be used for debt ~,~¢~ce,,Hence, h~gh~r capi~q~£nflo~ ~my be associated wi~ lower d~f~ml~ prohabili~!~,~S'To include cupid'4 in~ow.~, (,no may define a rat~o ~u~a]ogous~o t~h¢debt~:#v~ce mtm - Lo., the ratio of ,c~:bt--serdc~p~ane'n,~ to ~p~l' h~f~owa° - o r c~mb~e ~L~ two ~Itmay al~ob¢~O'.¢dthat e~s ~.,ri~h)low,gsnot ir¢~ld SI~i~'d~ by FI~211k'~ .~~ a~~q~7~), thc~th¢~coaldpossiblyb~ ~slUvely~rch~.~~O ~gz~l~~robab~sPj.
l
l
G. F ~
~
~
J~t, ~ ~,~dy~ o f er~d:t tern~
~1
l~n~ 'mod~ted dcbt-servi~ ratio' wtmre ~Jaedenomi~aator is the total of foreign exeh~mg~ earning. The latter is the appro~h u s ~ here ~~ As a balanc~ against fluctuations winch aro caused by factors beyond the cont~rol of th~ economy, one may consider fl~lble clemems m th* balance of p~mcn~J ~ x t am eantrolled by tim government v~thin some flouts. Forclgn cr.ch~mgc reserves, for instance, serve as a buffer ~ l n s t c~chaug¢ c a r n n ~ fluctuations Iu order to have comparable measures among countries, ~t ~s common ~o c~tmder a re,errs-imports ru*ao (or an imports-rcscrvo ratio). Wiflt a ]ar~r ml,~oof imports to reserves, one expects lower Dgc. AnothJ:r var,~ble suggested by Frank and Chne (1971) is the average maturity of debt (m~sured as the ratio of outstanding debt to currem amoriazation): a The)r ar~l,~u~m m dmt a predominantly long-term debt ~mphcs that debt scrvmc b u r d ~ c~-unot be alleviated ia the short mn by reducang th~ amount of borrowlug Given the di~culty of calcolatmg a reasonable measure of ~)mprcssible reaper,s i~nd the n*~d to have some mcmsure of deBcndcncy on ~mpotts, anothel possi01e variable ts the mtm of ~mports to GNP. In many devdopmg countn~ (especially those wluch have undergone an extensive proce~ of tmpo~ substitution ~ike many Latin American count.,-i¢~), a substantaal part of iraports is m the fotta of capitol and intermediate goods. Thus, the share of Lrnports m GNP refl~.s ~ d c ~ e of rigidity slnc~ a substantial cut Jn imports tmphes n constder~ abh~ lcvd of unemployment. Even ~fmostly non-e.~en~aal indasmcs ar~ a f f ~ d , unemployment is still a cost not casdy accepted. TImrcforc, it seems'~aat a highcx imFort-GNP ratto would lead to a hlghcr probabilily of default in the short run. ~9 Turmng to a somewhat longer ~ horizon, the growth of the eaport sac*or has bcel~ suggtlsmd to be an ~npormnt clement m D S C since, if the economy ~s not sta~,,t~ating, ~ts import cxpcnchturcs (and, very hkely, its debt scrwcc obhgatlons) m~ bound to increase. A growth of exports is thus neces,,ary tbr countenng th~e d(~lopments [Mikcsell (1962, p 3gs)] Presumably, a countxy w~th a h~gla ra~'e of export growth ~s less likely to default or ask for reschedulmg than otl~erwlse. A r~Lll~dvm'iabie that ¢~malso affect tl~ risk of de fault is export fluctuanons H ~ h e r c~port flu~R~.t~ou,, should ~neraily b: m,so~:~al~d wlth hgher probabi~tie!~ofu ,b,d~nce-of-])ny~len~ crlsls and, hen~, hlght:r d.~fanh probabilities Fol cxlimple, ,.t count~, cipo~mS primarily agricultural commodmcs s u b ~ t ~'WJt~: It~'m¢k~ USmlm th~ ~a~ ~, the c~rrdabon b~t~vcC'ath~ cal~italml~ow--dcbtt~t~O arm th~ ~bt-sra~,:~ ratio was 0.95. Hcn~, 11~t~o ratios ~ combined to avoMproblems *UA~al~y, t,lx~ ~z.vcr ~ ¢ ~ * ~ ' r ~ mfla,Alt~t~gh the~ ~sno p,~t-~c-Ma~r~m~on for tb.mr OA~b~a~ m~h ".~.~a~'* e2,0oi£-~a~P ~'~fio~xxyr~q~"us~t aa OFC~economywhich ts callableof
222
~. Fedarozd R.~ E~t, An.~ c @ ~ ofc ~ t terms
t~ ~etiodi~d ¢ao~ faihm~ ~la!/b= ~gardt~l a~ ha~rlng a lower .DSC, eeteria pat Ema.Ah~r (~Q6])hat sug~e~d that e~o~: fluctuations shntfl.d ~ ¢~cuL~tcd around a ri ,stag t~and s~ncc ~'q~o~ grow~ is ~ dL'drabl'~ indle.~tos. Tb-~sis the approach taken aere [see) also, Frank and Cihm (1971)]. In the long run, ~t Ires besa m~,,ued tha~ erie of the most importam £actors affecting DSC is the growth ofp~r capit~ dolv~'tl¢ product. 2° Tim is ~ factor, however, not comldcred by Frank and Clin¢ (197~). TI~ ~nderlying ass~pfion is that t ~ hmldng factor m t ~ long run is t.~) savings ~ap. Increased per ~pita output provldes ad&t~onal resources for bo~ d~bt ~ r v J ~ ~nd ~ s ~ d coasumpUon, h is usually assum~t t ~ t ~ processof ,~owth is ~mchthat expo~ sapac~ty is increased both fimo,'-gh e~paasio~ of ~ e tradi~oua'[ exports sector and by developing new indm~n~s producing ~o~export or producing maxke~ble goods wi~ch can be re~rect~d ~nto export c,~aanels. H ~ , one wnu~d ~p~c~ an ,.reproving debt mrdciag cap~]ty and a declininst probab~hty of de,'unit. Another mdic~lor whmh hm~ b ~ n sug~;~t~:l by Hanson (1974) is tee debtcapital ra~o. The underlying cxpi~uataon ~ ~h:~t th~ totat b n r ~ n ~v~r ~ long perlod of dine ~scompared to ~ ¢ overall productive eairacity repre~nted by the stock of capital, tt is ','bus a rather stat~ mcasm~ smo~ growflx oi" capital and debt ts a~samed e q ~ . '~z For l~r',,.cficalpu~osm, howe'er, it would s~.~ thut GNP should b~ used rather ,th,rm capital *dn~: in~-UionM compm2son ¢,f sap~tal s'iocksm y no~ always M m~tinLffUt, L~.) the productivity and q u e r y • ar~ not ~dways com~asabl,. A hig~'~" vah~. ~)ft ~ debt..~vP raho is ex,t)e~,~ to indicate a h~gher probubility of defattlL An additional factor whidt .'.~ayaf[~'t elther , ~ r t - n m or long-ran DSC is level of l~r capita income. Th~ a~gument ~ : u is that a h~gher l~vel of income .~mphes h~gher levels of non.nssenIial ¢o~st~tpdea (both ,pfi~ate and public). This allows the govctmue~,t more fle~Jbdity ~tt mrms of reh,.aslag resources for debt ~r~xc~ paymems ~md henc~ a lower pr(~:Oabdityof d#'£a~t. 5. EmpL~ieal~x~s~I~ The World Bank pub~l~es qt~rte.fiy data on pub~-icL~d ~Enroenrr~-'~, tran~,¢tmn.q. To estimate t~o mo~cl, 102 oos~'~fious o= p~,bhc an~ ~ub~eIy guaraut~l team fwvoIv~ng2/c~untr~es m'~,used for d:z d ~ t qaar~e= dufi:~3 1973 and i97~ 7 " ~ e ob~tvaNo~s .;ucI~de inte~e-~ m ~ ~ d ~.os,n damt~ou. Data for calculation ~:~f0 a~ ]pub~isI~'Jby '~m~MorS'~m G ~ : ~ t y T,~,;L D~t~. for '~.~edcmrndaan~ o! D S C ~,xe aw~a]ab]s i~ pub~.~tions of tI~ World ~:~a~, ~te~mfieu~l Monetary Fund,. arm '~h~U~l~ted~a~Jous a~d .~rc dx~c~sr~ ~a
~. Fcder and.RE. J ~ , An ¢omlys~z o f cre~++ter~r
~
det~dl by Fede~ (1976). The underlying assumption is that ba~kers use t h ~ IndJc~tox~ to evaluate the probab~ty of default ~n the short run, ,'roda duraUo~ factor ~ used to generate long-run probab[li~y under the assumption of approx~mainly constant sho~-run probab~Iity. Alter'natively,one may hypothcmzc that ;~m lender artctapts to csuina~c dzrecfly the overall probebdi~y usmg both long+ ran a~d short-~n Indirators and incorporatmg the dureuon N to account for ,[ower x~abdlt'y of loath-run proje~hon. ~ly way of summ~y, the rune economic m&cators used m the present study arc (I) the modified debt-servi~ raao (whach mciudes both ~..xpot'tsand cap~t~.l' ~ ows), (2) the dcbt-GNP rauo, w]uch ts an apprommaUon to ]Hnnzou's (1974) dzb~--t~pR~ ratio, (3) an exports ~uctuaUoas ~ndex,, (4) projected ex.potts grox~¢~ ra~o, (5) th~ amortmaUoa-dcbt ratao, 22 (6) GNP per ~.plh~ (7) the ~mport-ONP raCao, (8) the ~mport-zcscrves ratm, and (9) projected GDP gre ,vtlb rate. In addltaon, loan duration was conslde~.d as an explanatory vanabi~ hs ¢ ¢ ~ . n ~ ~Eould ~us reflectthe pure rlsk effc~t of loan mr~tunty Um,ag the at~ove defwm~ons for ~be x~ vartablc~, the ¢quatzoa m (13) was cstlmctted w~th the foHowmg error components approach F~rs~, c~t~mates of fl~, flz, , #~ were obtained by orchnary least squares usmg ~,lummy vanabl~ to reprcr.~:nt the tm+e (v~)and country (u+) effects; h~uc~, es~m ttas of the v, and u, were also obt~nsd as c<~$c~ents for the dummy w,,.zaabl~,. "['h~nc~uma~s of a,,;rodcr~were obtmned by eompu~ng the sample vananc~ of cstu,Uatc~d u+ and v~ T ~ estimate for a~ was based on the t~sadual sum of squa~:s, U s m g cst~mat~ fo~'¢,,,¢o, and c~, and erro~ cov~a'~c~ matrix was tJ~n astlma~d and used m coml~at~ng g~nerahzcd Icast-square~ estimates. This ts the method which was found[ to be superior for error components c~t~matzon by Nerlov¢ (1971) wh~.~n lagged endogenous variables am prescnL Although there are no ]agge,d endog~nogs variablesincluded e.xp1~c~tlyin th~sstudy, surge ofthe,:xo~ons variables m~:~y ~ influenced by perc~vcd D S C m pre~..d~ng)'cats In ad&uon, Maddala t~d Mount (1973) have also found tha~ this two-stage method and a number of o~Iel aIL~raa~w two-stage estlra~tes ate about equally sup¢ nor for error compone~ts cs~nmt~on w~thoat la~?,~.,edc'~,dog~.,nousv'~rmbles Furthermore, as ~d/Jm~t,~d by Ncr!ove (t971), the method ~z~,.'dhere is th~ c ~ t way to ~.~,t+re ~I pcl.~i~veva:dan<;-~,comr?one~t ~t~ma~:~ in the ~mbalanccd block ~.~ 2~ 'ThP:resalt~n~c~I~mates (m~d corre.~pon~g ~ n d ~ d ¢r~'ots)for the unobv~ vubl~ Ip~r~me~e~s ¢,f th~ model £n (13) a~e pr~cnted m ~abl+~ ~ ~+ [n c~c l ~11
cs~maZ~s h a w t i e ~ t : ~ A s ~ , but the ~uort~za~on--
Table 1 Rc-~ccsmonresultsfo~ l~e E~omazkct mo~.l, 1973 lind 1974." Vamabl,
C.as~ 1
CcSe 2
C~ts~3
Consent Loan duraUon
-3.5702 0.0559
--3.5730 0.0559
--3,5~63 0,0563
Mod~+A debt-~clv~ rat~o
1,2771 (s.H5~3 0.1057 (0,6~04) 0.1842 eL0080 --0.01~ (0,0127) ,-0.0001 (o.~zO 0.5735 ~'2.~Z~) 0,0252 (2.6692) - 1.2722
D e b l ~ l ~ mt~o
)~tlbor~J,fluctuat~oasmclcz e~TlOr~l/~t,ng-~Cbt Y~c~iO GNP l~c capnta Imporir.-G~-*,tPmtm .Vmporl~,l'~'vcsratio Prol~x~ G D P ~ h
~.2743 0,.870o) 0.1076 (0 ~ 9 ) 0A858 (LO~8)
M C ~ v~ac
ia sm~ple
9.353
L3115 ~o2,~o) ~'
0,096 (o.o~) 0~'~77 (0 039) 0.1892 0.62) (~.~S) (o+o41) 0,~.~ (C,O01) -o.ooor - 0.o~1 62~,0 (O.~.~gD (zA138) (Y~i4.O) 0.5718 0.6718 0.2~8 ~4073) 0A950) , (o,o~) 0.0~'2 ' 0.~237 3+155 , (2.6838) (2.6084) ($:.$36) -L2751 --1.36:/6 O,O&l,
,¢~r~znccsof d~,laale ~ivcn L,I~llhc~J, ~Bl~nlt~,~
a "v.5 percent level 2s I t can ,,tlso be ,~Iotcd from ~ e ~ympl:a~c F ~es(:lL,xt the mmuIItaneou~ly ~ r o ~ o t ~e ~+~jec~.L ~ul b ~ u ~ ,0t"~h~ I sycnploti~ r~ure of tbs~ i~a~, on~ is re~.u~r~'tio use so,ely ~ r ~ l ~ of om~ ~ e or P~othk~,£.
G, Feder and .R.F. J~r, An ematysfx of credit trrrr.s
235
es't~rmtes for the sta~asticelly important waxiabIes change very httle when the insi;paifieant variables arc "excluded.ze On the barns of these resldts, It may be concluded that at least six economic indicators seem to be related to DSC: (1) the mochfied debt--servlee ratio, (2) export fiuatuat~ons, (3) the maports--reserve~ reao, (4) the lmport-GNP rutao~ (5) GNP per capita, and (6) pxojected GDP gro~ th While the first four of these varhb]es may be consdered as short-run inventors, the last two relate to the longer run. This ~s consistent ~lth the fact that most of the transaction. included m tbas study are w~tlun the range of 7-I0 years, wh,eh may be cons~de,'ed long enough for lenders to aT to project over~l development m the economy rather than samply the growth of the export see:Lot. Exportr,. however, are co.side.red important tot shorz-ru:~ ask eva!u=uon ~, reflected in the debtservice rauo and the export fluctuattoas index As for the lenders' underlying ibehavaor, ~ e re~ults may support the suggesuon that b~nke~ try to estimate the overall orobabthty fro, the full duration of the loan) ~ther than a short-run pz~,hahd~ty wtuah Is then assumed constant for e.~eh year. The outcomes al~o corlfirm the hypothe~s that loan duration ~as a pure (poslt~ve~ risk effect on the probabd~ty of default az perceived by the lenders. 6. P~ree]ved DSC fm~ae EnredeIlar m=r~et ?eree[ved (or subjective) prohabdltics can now be esUmated exeapt that flo ]s laot identified {otdy p~ = flo+/L+l~ Is ~umated). However, :forte considers various hypotheucel constants, some insights are possble since the ordenng of probabiliues is not affected by arbitrarily changing the constant. Table 2 pre~uts e~tamates of the snb.leeth'e prohabihue~ for |he 102 obsexvut~ens ~ath several hypothetical values of flo. It seems reasonable to expect that the subjective probab~hties wdl not assume very high values since in t~at ~ the interest rote ~sproI ~blyso hzgh as to deter tJa~. potenti',.d borrower. In this case a constant term between -3.25 and - 2 i n ~ i c e ~ an a,,'era~ prohabdlty or" default from less than 0 1 to over 0 2 AI,tL~ot/~ the ~ m a t e d s~,~bjectlveprobabihtles do not include any extreme v~lu:s, there Ls s~l! considerable va~a~aon One ~ n show that the model p~zu~ed ~n ~ . f~%t p ~ of *~s paper amphes I~gh sensittvity of the interest m ~ n to s m ~ vanz.~nns m ~he prohablh~es, especially when the prohabdlues ~ c relat~vely ~ow. Courtier, for ,~ust~nge, the case of r~k neatralrty ~ud[ suppose ~t~t, ~br n borrower with probab~lily ~£def~mt: equal to 10 percent, ~he m t e ~ t m a r ~ ~ e ~ O.SOof t percent. Svr;p0se now that the prob~Sfilty racreases to ~5 percer~ v/a~c ~2 r~e other er,em~t~ remzln constant. 27aea, using equation vanr.b~ ~z~ r ~ o n ~ i ~
~'~rm,A~'~r~..,e of,.l~tmew~LIb.~ ,n cn.~csI ~ d 2, In fact, it ~zn
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(10), the new immest margin becomes 1.27 percent. This is an i n c z ~ of m,>re titan 58 percent m the intcllxst margim )'n general, the d~ficity c f ~ . ~ ' t m~lgin with respect to probabd*tZ chan~gesis always morn ~azauun~rf (for ttz, c~ae of risk neutmhty) since dlffe~:ent~afi~gthe Iogaslthm of cq. (10) obtalns d r 2~ dP r
I I-2'
P~mIlh~g the de~/~on of ~ , it ~s cvldent tb~.t asmlmptioas ~boul ~o have implications for demand classify and loss rat~. These ~mpl~*~a~o~s can be e~,aramed most easily under the assumption of/ask ncn~mI~y Which ~ bce~ argued to hold as an a~pp~oxlmation. In this c.'~se,~ =/~o+In~i+# where/~ h the expectation ofln[r//(~--I)]in the sample. If average loss rate ~ ~s about 0.I0. then the case 3 ~:~mate o f fl~ ~mphes that ~*= - 3 . 4 6 3 - f l o - I ~ ( 0 . I 0 ) = - Lo~37-~o. Hen e, m the, = k ~ of Hs~ neu~zahty, it is not masoae~ble to co~ '/Ier #o > - 1.23 smcc that corresponds to ,a < 0 and thus impI~es a pos[fiveJ,y d o ~ demand c~rvc. On the other ] ~ d , ~o a~Jy ~'ghdy less tlmn - I . ~ 3 co~re~oa& to large r~0 c., very chlsdc msidu)fl demand). Finally, as/~o l~¢ts l a r ~ ~u absolute val~e, (he imphed d~mand eIa'~tid~y contlou~s to decline towa~l q = I O / = 1.1556 at flo = - 3.25). ]~as~d on the vamlace compoaen~ csfima~.cs,c¢'~eral corii~I:t.[oaa]coaclas~oas are. poss~ble, Th~ v~dane= c~mpoz~ms esdmatc~ for cas~ 3 :ia t~ble I (which a ~ apprommatdy the sa~mcin ¢ a ~ I and 2 ~so) ate)
t,.e ~o :xp~.~ned di.~t~r~ane~s. ~u~ ~ th~ context of ~ model oftt~s ~9~r, ~ y cu%'e.lc~ m countr~,es arc due to d~'cr~ng demaa¢~ eJ~t~c-~ti~, difl'cr,~ngIo~
~urodollzr markeL Tcchnlcally, however, these s,'n~e obs~'wlaons would also be possibie if residual demand were h}ghly clasuc but perceived loss rotes were quite d~Ecrcm for different countr~. Differing n.~k attitudes (alone), on the o@~r hand, cannot le~l to t t ~ e results u n [ ~ risk attitudes (of the negotlatang bank) vary systen~o.dcallywi~ tlm country, i.e.,a country tends to obtain all o.r its loans from the same bank.
~ is .,nt~resfi~ to compare ~hc estimates of lender's" subjc~-~ve det'ault probabib~es w~th the rcsul~ of obj~'t~ve ~tud~cs w~¢h have attempted to estimate t,~e default probabflm~s. Objcct~v~ s~dms of default probabdit~es h,~ve been made by Frank and Clme (197D and by Feder at~ Just (1977).Comparing w~th th~ results of Frank and Cbae, ~t appears that m:~uy more in'¢k~,~torsare its, corporaU,~'d m the ;ub~ccave probab~ty tlmn anmally ba~e a significant effect on defau|~ probabdlt'y;thor resultsmdi~xttcd the objective nnpormucc of only the debt-se~ea mile, the amomzauor~-debt muo, and possibly the ~mportreserves r,~fio. However, tholr smttsucal s~Eni~Rnc~ tests wcrc applied moot ~.cfly m conel~ding the ms~gmlicancc of other variables; and several potcr~tmlly ~apo~*~.~t v,,anablcs were not considered. Using at least a~ympU~t~calIyapphcable smfist~cM t¢sts, the Fcdcr and ~ust stady ~ndic~c~ the .~gn~cant importanc, of at least ~'¢ mchcators m the objective ~sdmafion of default probabilities. TL,=sc include the debt-service ratio, tl~ i m p o r L s - r c s ~ farm, GNP per capita, the ~pit~tl intlows-dcbt scrvic, rode (whmh ~s combined vnt ~ .~e dcbt-.~rvlc~ ratio to ibrm the modiRed dcbt~smwio~ ratio m tim present stud~, ~ d (ahhough less signifi~nt) GDP growth. 2~ All th~se variables appear important in the s~bje~ive resultsas well (table i). ~c~uso of th~ meth~,d of analysh (d~s~dmlnant analy~s) used by Frank ,and CLio© (1971), no estimates for ddauR probabfliues arc p~ble; but the Fader a~td 3u~ study uses lo~itanalysm and hence allows the objectivecs~mataon of d~au~t l)robnb~liues f<~rthe same ~ o f ¢L..~used ~n *.he presem subjec~zve stu, ty. TSe~ ~e;,ultsc~anot be rcr~.~,cdhet~ bc~mu~e of theirIcn~d~mess, but the dff~:ran~-----'s~ stnlun~. U~ng ~bz obj~ttve model, csmuat~d default probabfl~Ues from less tha~ 10-~ to mere *.hag 0 99. Ex~'pt for four coimtnes, the et,fim:~t~ are ~l I ~ thai 0.~)i ~l~tb2 e ~ m a t ~ v f lenders" subjeauve probab~hucs, h o ~ g e r , if~eo is adjusL~d so t h ~ some subjc~:i~eprobabilities~ e in the ne~gkb~ood o£0.,91~ tI:c~;~I subjcctwe probabdivj esumates f~l under 0 1 T h ~ ~,S~m to be coe,*,~t t ~ ~ c~t~ciz~ by I~ow~.xd(lg7 2) and von C ~ m (X~)Tt), ~f~.2~C'to tL* q:x~'Ry of risk :maIyg:u ~n ~he Euromarket
, .... : , , ~,, .... , , ...... ,, ,,,,,I , ,~ T ~ e ' i n ~ ' t au p ~ h used m t.~,~study, ~s has ,od'on the nohon that the pro a~illty of default is one of tl~ factors entering l~ders" decls~om regarding the term> of credit to be c~rged. The xno~el describes, the va,~ious'¢len)ents ~nvolvod in the de~rm~atlon of the r~te ofinterest wi~, special reference :~oprocedures of the Eurom~keL It yields an equilibrium relation between the ~,terest raargm and the probahiilty of default which imphcs higher interest for ldgher risks. Other factors which ait'cct the interest marg~tt are the elasticity o f residual demand for lo:.~s, the locreeiwxl rate of loss related t o default, and an extra premium due to riskaversion,~atb.e~.zr¢ of the lender,
Assuming a log~ts ~ . ~ a o ~ for the ~latlon beW~e~n the probabilityof default and ~ d o u s economl,~ i~'hc~tors, the equahL~iam relation betwc~u the interest m a r s h and the probability, of default w ~ then tl~J~stbrmod into an ecou~rnetrie model. The parameters of tic model were c~'t/mated using Euzom ~ k ~ dam on publiclyg~t~Lr~nteedIo~us. Rcsuhs suggestthat slx econon~c indicators slgnifica~tly ~ e c t ~en~rs" subjective ]~robability: (I),the modified debt--service ratio, t2) income per'capita, (3) the, projected rate of growth of GDP, (4) the import~re~erves :a~o, (5) tlt¢ share of amports m GNJP,~ana (6) export flactuafions.~a t~dition,it wa~ ¢onf~rmod ~mt ths'~atunty term of the loan has a positive ~,,ffccton ~ e subje~-'tiveprobability of default. Using the ~ m a t e d coet~ci~Ints, :endsrs" subj~ctiv~ probabilldcs were also estimated for cac~ spcci~e tma~ ¢~don observed..Compsxing ~ t h objc~.Civemeasurements of default probabilities, it ~appea~, '~L~t'soroe nmprovements'.in lenders' subjectivo probabilities are (~os:tibla. ' . .' . .' ' . ' ' . .' Finally, the results of ~his study suggest s6me ~nteresdng possibilities for pahcy formulationin borrowing couutdea.Increasingly,d~elopit~gcoantrles ar* entering conL~ierc~ulcapital markets for funds; add, of course, the av~i|~bifityoftl~e fu~dsd~¢ud~ on how lenders~e1~:~ive'the.~ DSC. The eonttoll~i regular;onof im~,~ortantD S C indif~torslcanthusbecome an ~mpoz~antpartof government poFcy i,. reaching many national ob~c~vcs ~ e ct al. (1970), Hansoa (1974)},A stud:~of :h~.~ poli*/'-rclat~dL~sucsb,~s~Ireadybegan and ~qcur~.'vtly bei'~g ckpssdcd by the antLer. ~ut the fotthcomlag t~ults witl bc trusted in ano'~er pal~*. '
~3(;-,67.
more,~ ) ) .
, , .. .
,
'
~. Feder and P.2L Just, 2,'~analysis of ~re~t ¢erma
243
I ~ . and P,.M. Cye~ 196S, T ~ r y of the firm. l ~ u r o : a]locatJon m a marl-et economy (Prent~e-I-l~L F _ , ~ l ~ r ~ Cliffs, N.D Cox, D., 1970,The analyss of binary,data (Mcthuc~, L~mdon). Faadand, $ , 1967, C o n ' t r ~ on Mr, G uh~u's paper, m: LH. A~cr, ed., Capl~l m o ~ t s nnd o~onomz: developmem (St. Martin's Press, N¢'w York) 26t-264 ~ G , 1976, Default risk md~=tors m mterr~nt:o:~lborrowing, ~publt~bcd PE.D dls.sert~tton(Umversily of {~xkfornm,~k~rkclcy,CA). Fcd~, {3. and R.E Just,1976,The Etu-cdolhrm~kct: A thce~,'Jcalamdy of lemhng under deleattltrisk,Working Paper N o ~0 Umv~slty of C~iform~, Department of Al~cuhura] and Rcsom~ Ecoaom~, Berkcb,:,CA) Fe~cr, G. m~d R.E. Just, 1977, A szody of t~:bt servicing cavalry applying Io~1 anMys~s, Journal of I ~ l o p m c n t Economzl~, fottl~commg Fn~h, D., t951, Invcsm~at servxce of und¢,Mevelopedcotmtrtm, IMF Stuff Parers ltl, fJ0-$5 Fr~tk, C.R. and W.R. Clme, 1971, ~I~uremcnt of debt scrvtcmg ~ a l ~ t y . An a~,phcat~on of dlscnrnmant nn.dysxs, Journ,.d o"I~t~rnattonal F.conom~cs 1,327-344 l~zrth, J,H., 1973, I~teR-nnt~onn|doffar ~lqtudtty av.d the Euro-dol]ar mRrkct, De Ec~r~m~$t 121, 347-361. Gulhau, P~.L, 1967, 'I'Ve ~ for fco*~n r~ourccs, a~orpove c~pat~,, and debt l~r~ ms Cal~Clty, m: J.H A~lcr, ed, CRr,lud rnov~n~ts o ~ cconorm¢ development (St, *.~arhv,'s Pre~, New York) 24O26O Hamon, ~A., 1974, Optima! m|e~'n~u0nM borrowing and lending.. Amer,~m l~t~oncrmc Review I . ~ , 616-630. Hewson, 3.1~. and E. SMmk~b~t.w.1974, The Eurodollar depos~ r~,.~up]~er A por~k~ho approach, ]MF Staff I ~ e , ~ 2Y~,30T-328 Howard, p., t97P. Med~-~mm hnd~, lead ma~agta~ and medaxm-t~m t,oma~, Ee ow31~ey, 18--2L Irwne, R.J., y . ~V..~'om arm H . F Loe, 1 ~70, How to ~ r ¢ ~ succe~,fu]]y, Co~rnb~z ~,~ar ~al ¢ ! World ~mm~,3 5, 42-48 y ~ t a ~ c l x ~ . C.P., 195~;, Ee~n~mm de~le]opment ~3M~raw-H~IL New ~/or~ 260-27 '~ Levln, J.H., 1974, The ~ r ~ , l a r market and tae lnte~attomal t ~ e ~ o n of t ~ e ~ r ~ s , Canad~a $ o u r ~ of ~¢~,~omk* 7, 205.=.,24.
Ma~dala, G.S. ~ad T.D. ~0o~, 1973, A comlx~,m~..~s~ad~yol a~iv:rt~n~ ~s~J~.ids ~r S~/Asscci~on
t' ;, 324.-37~.
lmvatc ~ud f ~ a l n ~ t
I~ , t ~ t
I67-t74. 2~-95,
~bro~d ~U~rve~,~ty~,~fOrc~on, E~J~'ltc, OR ,,
tr~s2u~en "Uaexe is ~ o d o u b t ~,h~t 1~: p t u b a b i l ~ y o f ~ - ~ a ~ t m i n t e n ~ o ~ b o r m w l n g is ~ ~o ~ e eco n o mic d ~ t e r ~ m ~ , of ~ebt.~ervieing ~ p a c a t y (DSC) ~md that !endcrs ~:r~ g~.=fiy e o , ~ = ~ d w~lh th= v.zm~e of d~= llnk. A Iog~c~ Lm{ l~eafion of ~ S f ~ ~S th.'t~I~I~tfflT2.Sof cred.~ cx1~gRd,~ ~0 Varloss bOrl~3Wct~ (as f-.ga"as ~=r'/r~, ~ : de=~.5~cn v ~ b | ~ on the p=z~ o~ d ~ lend~r) are relentedto D S C as re2~r~'d din)ugh '~he probability o f de~hnlt, E~ -en, L'~ca.¢.~whs re th= te~m~ of :~ed:. ca=not be ~/ffer'~lda:ed (e.g., n~a-eor~zwr:/at mtc:nazional or~_n~zatic~, ~.t~ a y b~ L ~ ~.~ volume o f c n ~ - ~ l~ m~qi.~cn~d by t%~:probab~hty of /,:fatd~.T[t'aS, a ImLeW~Se of~hc ~'t[ons{f p 0f &.~na~nlut~ of D S C and the pzoba'b~l,y 9,[ dCi'O~L ~, o f ~r~e,r e ~ so£ 02.~l~,%0'lena~'.~ b ~ ~ds,):o oorrowers,
,~rcd.~ ~, c ~ ~L~ d~:i*a:, Z,~twc~n !937 : ~ t ~974, the ~-..r: o~ p~vate cre'.h~ors
3~22
,
G, .Fcde~" a n d
R,~, d#2;t,~MwralyMaof credit terat~
m g ~untries. While in 1974 Icss-dcvelopod countries (LDC) accoun~xl fo~ a ~hird of publlcizod Eurocurrency ¢;edits, 58 l~rc~n`tof publlcizcd ~ran~ct~ons h~ ~ fast half of 1975 involved dcvelopiUg countries. Th~ purpose of this paper is to inv~t~g~te the rclatioRship of D$C, the probability of d~fault, and the terms o~"credit obtained by devcioplng ~ountrics m the Eurodollar mark*t. Fir~, a tlm~)redtml model is c o n s t t ~ e d which desc~~bcs lenders' detarmmataon of credit:tt~rms in a framework of monopohst~c o)mpctitaon.The theoreticalmod~l ymlds an equihb~um cand~uon which demonstmtcs the rcla~onship of d~'aul`tyrobabfllltyand the tcrms of credit El:tsttcaty of loan demand, th~ pcr~ve.d ram ,~)f~oss in the event of dcfault,and r~skavers]on arc other f~tors whcb apparently eu~r the v~qat~,0nstup Reprc.,,~nllmg the probabihty of default as n funodon o~ DSC ~m~ica~ors .~n the log]t form [Theil (1970)], it becom~ posslbte to eoonometnc:flly estimate the ~s~l~ng equdibrmm r~hfioasl~p. TI~ model is thus apphed `to the E~rodollar m~rket to investigate "the empirical important: of various D S C d,-~t~inants and tmrceived default probaMhty in detlerrmrJng m~ez~st rates. 2. A med¢l of ]e~ers' d e c ~ o n - ~ , ~ g ~ ~ : Eurocu~c~cy ~ r k ~ Lending prattles in the: Earoenrren~; ~ r k e t differ from h-*,dltiomal banking procedures i~ several respects. 2 Th~ rote ofimcreslt in Euro~urrcncy transat~iens ;~ composed of two dements. (I) tho Lnterbank x'xte of interest and (2) th~ iu~res`t margin "lhe intcrbank rate of intetcst-wmatly tefcrr*t~d to as the 'Lcmdon Interbard~ Offer' (LIBO) rate - zs th~ th~e,-month or (slx-month) dcposli rote. Almost all transactmn~ allow th¢~ LESO rr~t~ to flo~t as a ~ . s u r e of prot~tion Io the lender, a~ud the MBO --ate is iv general tim s'~m~ for all borrowers. ~ Tim interest 'margin'-also refer,~cd *o ~s the ' s p r e a d ' - i s ~ fixed rate of mteres`t char~ed m addition to the LI]30 rote. I' daters from '~ra,nsac*don to, transaction and reflects both the credit worfltin~ss ~f `the bo,:rower and ~ e Io~n duration.The margin ~sobvaously associated w~th ~ pro~: margin of~Itebanl~, s m ~ ~ L!~O rate is cle~ly r~latcd `to t ~ cast o "eapit~ to ~a~ ba.,d~. Typ~e23Jy, a Euroloaa is '~danted in *2to form ~,f r~woXvmg credit, Le, as a short-term a~Jvem~ which has t.obo r~n¢~md ev,~ six montb~ for *.~ duradua of the comuntmen~ period (whie,h may so~t~m ~s be ~,, ion~ a'~ _*$ y~:~) Th~s procedure oft~n l~ads to a °ba~loo~' lbrm o ripay~)en`t 0.e., r~:paym~:nt m one iasts]Imeu~:;~t*he end of*.hecomzcd~2nen`tp*n.)d). , ~A com~IgL~~md m.x'h lx~t-~l l ~ h y ~ c a ~ a t oi t ~ mcdJ¢l~ ,l~VC~zn FC~.~,tand J,~ (vnoO.
G. FaCe..-'~,P..~ J ~ , ,.~ ,r,a'b'~ ofe~dl~ t~,~,
223
Most of ~tc lending in Euro~.u~en~ m donne by syndicates of baul~ or by consoz~t banks aflbrdzng a much ~.~tcr d ~ b u ~ o n or n s ~ U s ~ l y one b~nk serve~ as u m~na~er Goad bm~) and eonducls the negobauons w n h the !~7ospccfive borrowe.r 'A comprehensive evalua.~on of ask is m)rmal]ly mndc by th~ lead hank 'with p~t~cJpanz banl~s relying almost cxcluszve~y on the infornm~on prodded by ~ c lead b ~ L °'~~lut there ~u"eu number of factors which produce d~'~renUebon betw~m b ~ s both wltbm the n~rl~:t ~id wi~ rcspcc~ to o~Jer finavdal msutuUons. For cx.~oplc, b n ~ s &fief in theiramtudes toward ask because o'Jd~fferen¢s~zcs or dd~ercnt prcfenmc~. Also, mlbrn~uon on cretin m~vas~s hm~:d (at least danng the negot~auou process) sine: neb'ouatton~ are ~cpt secret; and, b;tn~.Smay offerd~ffcrc~t opUons with re~,ec~, tO the c arrency tO be used at ",.hetJme o~ repaymc~t Thus, the Eurocurrcncy marke! appears to be a c~c of monopolistic comI)eUUOn [Cohen ~ d Cyer~ 0955, pp 207-225)]. Accor&ngly, whvn d,:~hng ~qth a poten~al borrower, the bank (Dr the Ic.~i~ngbank) fac~ a dog.award qlowng ice,dual demand c~rvc. The residual dcr~mnd is determlocd, by tl~e o~er,d| demand of the borrower for cx~crnal r~sou~ccs as wc'.'ias by ~tsrnauve sources of supply. 3"~'.se alt~rnaUve s o u ~ , include other financial m,~'kets, bonds, o~her banks m the Eurommkel, th..country's own x~ou~cs (in t~: =~s~ of a govcmm~.~at), etc. W h e n nego~athtg with a polcnt~d hor~o,~er on a possible loan, the ban}: is aware of the possthflhy that t ~ |o,m ~nd m',~es~: wil~ GOt be fully l ~ d if the borrower does not (or c~mot) meet obl~t~oas N~rJon~J defaults (in the sco,,c of tmw~11~n~ncss or ~n~bd~ty on the part of governments to honor con'tractu,d obli~fion~ to f o m ~ creditors) I~v¢ occurr~ in s number of d~eloping countries since World W~,~ ~]~ U a l ~ the p~war era, it has beer~ common for the c~ed~tors and the debtor ~o work a rcsch~duling or refunding that provides for delays ~a debt service,reduced m t c ~ t rate.a spreading of maturates, ~md/or elimination of part of the loan ~ Such arr~cmcnLs are advan~eous for creditors b~c~use they ¢ o u m ~ the bo~ower ~o at least a pazt~M rcl:~yment ~ d also for deb~o~'~ b ~ u s e the nec~ for lordly ~.~mnouncmg default Is chmlmttcd ~-~evcr, ~.hedebtor's advantat'e ~ay be marc ps~chologzcal ~ d pohui~l than ccouo~o d~c~ ~ Myr~L~ (1970, pp. 291 and 292) cor~nen~, such e~raogc : ~ t ~ C¢C ~ J b ~ bV~ 'r,more cof~sidcra,'eway of ,'Itm'~a~nga ba nknup tc~" tn rues: of th~.~"cs;mct~,~h~ cr~F.om incur some loss e~ther because payments ~ e dc~,~tyccl~ d th,=r valse is reduced duc ~o inflation or because there ~s ~tcs~u:~ ~o sol~n L ~ i C ~ o~'crecEq or ~o write off par~ ~f L~C debt In vdd~uon ~r~t~or~ c~)~ ~ ~r~cur~C~n ~ ~rocc~s of rc-~cgot~Jon. A ,~sk ~ u a t a o u
and tim loss that may be ~uff, t~fl ~a' the event ,of de~autt.',Saeh an em,thmtioa obvio~|y focuses on t.he eeo=cmti>¢hare.eter~l~ o~' ' ~ country as a ~,~Jlo~ ( ~ ~ e.~e o~ pubh~ or pub~ciy gtmrante.ed k~ans) ~ c e ~ h ~ are *.he d ~ r m~nants of D SO.~ It ~ s~m~ ~easo~b~ ~a~ ~h, pmows o f risk ~l~afio~, provides "~ae bank with so~a~ (subjeofivg0 nofibn o~"fl~ ~robab~ti*y of d~t~aull~, F~rt~rmore, if b a ~ s are ¢~nc~me~dwJ*dzthe ~mW.o f l o ~ ~.h0.~isin~a~m~f-fol~ow. ~ g a default, then :z s u b j ~ v u L'~obabi]ity- s~.y, W(~)- :i~l~I~.~ f o r m ~ fo:r loss rate h, g~*en ~ae the full term~ of the agr~.~mrmt~ ¢ no~ m¢~(Lu., g~ve~*.~l default occur), t~or .no=tJonM parpos~,, let *dxeraudom wat~i~b~h be eo=*~2iued in the rang~ Lh, X], where h = 1 Jmpge~ ~. complem ~o~s ~ld ~ ~ ~!hem ~ h ~ t expected zam oflo~s; h~ce,
It is re~nab~e eo ~ssumo thz~ 0 < h dne~ countries wi~lLavoid clda,u~ (or reschedohng) ~f flae dullest is r~lafively smML W21ea default does not occur (which has probability ~i-2~(X)~, ~,~ ba~k receives ~t~net Icveaue oJ~r-L(r) e~teh Nero'throughoa*. ~he d umtJoa of the• loan where • ~isthe inteze.st nlargm ~md L is Lhe slZ¢ of ~*. ]oar*~~ The slz~ oJ"loan
demanded obv~o~ly dal~ends o~i wbc~'tthe ;borrower ex!p~.m'regatdiu~tlm beba,~ot oftk¢ L ~ O ra~e during t~u pc]dad of ~repaymc~t, b~tt thls is ~Jvetze.r.ogenouMy for ~Ja¢bank. Honor, reddtm] dema~.d re!: l c o ~ h; reprcse~.*ed, only as a faacfic-_ of ¢he,margin ~ , L I~ Z.~r);
aLlOt = L, < O.
(2)
Suppose Lh~:st~'a~ o~xlet r~.'~.'~es "isdiscounted bee..u~,~of~he c~¢ ol eaplml to the bank. "Ihe oust of e,apiWJ(wl~clx i~sre!,',t~d *o~.he L ~ O ~'.a@is =~>~~r.~w= a priori for ~,heend:re d~wa~o= 02 the ~o;m, b~.~~ ~. ~t~0on~i.,~)zo as,~mz ~x:~ th~ bank l~; ~ome ~e~ghred no~on ¢~? t];e cc~ o7 ~k~taX ( ~'~',r*) tXL~.tmt'.y prevai! u~td tim le~t ma ,~res b~:,ed o~ cx~$n*-n~* ~:~d r&xF~t:~Ja:~.USU~ X2~A~
]~t'¢clvcd r~¢ to d~SC01,~R¢tI~ net rcvcntl¢~s,3n¢ obt~ns
= rL (Ill
-(l +r+)-~/r *)
= rLO,
(3)
whcNl~
and A' .'sth= comrmLm.cm period or Io,'u~dumuou. In +he case of a syud~c*~tcd ~oan, one may coamder e. fr~ct~on of the I~oa.u(=L) w;thout clu'mt,'~ug rd~c mendel as long as ~ is prc~ctcrafined. For Lhc purposes of th~ paper, ~t ~s ~sum."d 1~,t ~¢ bon'owcr s Cl~l crccht fo~ a L~Ven duraL,or, hence. N i~sd¢¢,c'rrmncdLcxo*jcnously ~or the lender. Suppo~.~ tha~ th~ bank Iresa u~hty f~mction defined on nct d~c~)untc,i fcvenuc
u=u(a9, u'>o, u"~o,
(4)
~nsimplying rhk a~c~on or risk ~ev~rnIRy.C.~venth.~s~Umfionof ~n~nmV/, it Ls ~s'am~d d~% ~ Icndcr's objcct~v¢ is to mm,drm~'c, ¢xpcc'~.~d ufiIiv: by o~tim~.tly choosln~ the in~t,~st margin r. Lc.,~
G. ¢~r~.'2R£.Jg,%,~nanal¥~ofoedltter~
The first-order eo~. i~iou fo~ maximization of (5) requires I° . . . . ~
( I - , ~,: ,~ .+L).v'(rOL~-PX.A~ h ~ ' ( ~ ) e ' { - ~ } ~ = o.
,'
(6)
From this cenditioa, an econometric r e h u o ~ h i p may be developed as follows• Rearraog~og ¢q• (6), one ohtalm #.
P tl ~-t
t"~ e ' { - h L } . h . ~'(h)~,'
[l--e~O 2~-
V'{rO~}
'
(7)
where ~/is the da.~iadty of demand t'or loans,
= I,L, ILI.
(8)
Sm¢¢ r should be non-negative and U' > 0, it follows dmt ~ > I at the poit~t of optimality. In order to summarize r.h¢ factors ~beting interc*t margin, it is useful to consider eq. (7) assuming, for slmphd~, that h talces only one value, ~, r=A"
~ '
Here the term, r//t~-1), rcfl¢:,'ts the b o r r o ~ ' s t~argainlng posNoa wNch deponds on alternative a s m ~ of supp'Jy and the overall demand of the bo~ower. The factor 0- ~ is a profi.mbiliD" pam~meter xelated to both the, discount rate and the duratton of the loan. The risk asp~* of loan maturi~ is h~'~judcdin ~ c term, P(JO/[1-P(X)], where N (loan dum,tion) ~s an elemcm in the X factor. Other economic indicators are also R',flect,¢~ht ~'.lasterm wh/eh is th'as t h e / ~ k betwc¢~ DSC (as perceived by the ~eradc~')and ~he *erms of credit. T'.,e ~ast term, U'(-ld~)f U'(rOL), represasts the ex~a fi,~ prenfium that is chargt¢l due to ri-d~:'averslo~ on the part oft'he lender. C~Vithr/sk ne~trMi~, th/~ term is identically equal to ~L,0a'gcr'*J~a~ X.) ' F ~ p~cm~m,, while uader ns]: .,,version, U " '< 0, it ~s a l ~ however, may be l~egt/#bi~/fthe voi,±~.~gt.~-'a ~.~sac~on (Le•, ~ vol~un~ of L or of the person e l l ~:~t ~'~~ d e r t ~ u by lhe, baak) i~ atoM1 gelafiea.to Lb2~ Another property of the ~ode~ w/M¢.h/s u,~,ffld ~ i n ~ z ~ , ' ~ ~-'~,~ae~¢~ ~esults with the medal ze,I~s t~ r h k n e ~ r ~ , ' ~ m d y , " i~- fl~e ~a.~ ef r~.~
6. FeA~ ard lLI£,l~,.da aad~x;aof cred;tr*nm
227
neutmlit'y(wlm~ the tlskaversionp ~ m i u m isunity),'d~ model in (7) zeduce.st~
r = ~=i-~Ti;-e'
(~0)
wher~
whether ~)r net lossra~chas a sm~al~ distributionas m (9) Hence, to the extent that Earom~-kct lenders arc risk neutral or indiC,dualtralnsact~or~sare small tx,latlvato totalwe'<d,econometric interprctalxonscan bc greatlyslanph~cd t~ Furffiermore, tht..'se coadil~ons inde~ seem plaustble m the Eurodollar markn~ bee~se of the sine of fi.sancmlmshtutmns mvo'~vcd and the extent to wbach loa~ may bc syndacatcdor chstnbutcd among b~mks.
3. An eco~me~'~c ~'m'm~,~J~en "I~ au~ysis of t~c previous ,~ct~on has p¢,stulate4 tha| the n~k of default is one o,~ tbe factors determining interest margin m Eurozm~rket transactions, Risk ;s vcprcsentcd by two components: (1) the probability of or=fault P(.I') aud (2) ~_be rate of Ioss h or its chstributton ~(h). The function F(X) may be rcgard.:xl as the lender"s st~bjectlve probabihty of default based on av~alable economic data for detea'mlnan'~ oF DSC. "i~nat is, th~ v ~ t o r X ss composed, ia addifioR to loan dmataon, of ¢¢ouomm, variables which a~'e considered by lenders as r~Icetmg DSC. Hence, while ob~rvatioRs oa subj,~tive probab~htics arc not c~vmlRble,~ on economic indictors e r a be used to estimate tee re~atlonshlp In (9). To do th~s, b o w e r , R is necessary to specify a functional ibrm for the ftmcti0a P(X'). Such a functional form should be boandcd between ~ r o ,~d o: ¢ for att values of X and should be sufti~c~tly 'flexible so :h~t P c~m ~tcrcase wP,h pas~Uve ;sk indtc~ttorsand decrcas~ wztE erccht-wo,rthmes~ ,~ndi~tors,,O ~ o~.*~;~emosi widely us:d spec~=~nans for probabilityfunctions wbSch s a ~ e s t,~es~~ £~tionsis tb~ logist~form [Cox (1970)],
i
w/ze~ ~'is the &=¢r~J~a o f . ~ U's~g'ads ~,'~icat~bn~ ~owever,one finds ~ a t the logarithm of odds is l~¢ar in the parametezs
and,/~n¢~, tiae structural equation in (9) may be writteu i~t logarithmic form as
+In
f(f'
L d~
v
?
k~(h)U'( -/',L)~tdh (U'(rOl'.)) . // J
(I1)
Turmng to the other ~ertr,z in the model, recall tla~ 0 de~ends o~ N (]oma dnratzoa) wi~eh is obse~w'~bl¢;tad r = (t~e per~jved avez~ge cost of eapitrd) which is not observable. Hexc one may postulate that r ) depends oa historical LIBO rates singe expectations are usually based on I)~st experience. In tbls context one might introd'tt¢~ a distributed lag r d a t i o J ~ p for r* or' simply postu~zt¢ that r * ~s an average,of past rates, For siraplJ,=ty it is assumed,in the empirical part of tbls paper that ,the e.~pecled,r* is the averar.¢,of LIBO rat~= in the 12-month period 9re~'Aing *.he~m~?etionY = Hentc. ~ 0 ~.r,omc~ observable and m ~ t simply be constrai~gd ~ ' ha~a a eoeffident of -,=L The elasticity of demaud for loans ¢a~not be observed; ~ , the te=~ rt/(~/-~1) is not known. S ~ th~ eba~icit~ is ~ u n ~ s;p~" e, the ~ltrod~fion o~u,country dummy vat/ablemalt sUffr~e,,But.~ clas~ei~ may also be r ~ i ~ e ~ ~y ~ = effects.For instance,when.supply ¢,o~dons in the Euromar[~etor.othermajor financialmarketsam changing,t~ r~i~..zd~emznds fa~mga d~!~ E~u~.)w.~d:ee lender w~]Iz~J be eh,2.aging,~n't~c sam~ dire.e~,on. ~V~o~ovcr, ~ f~r obgervairons relating to a glvea c o . t r y at a given p~n~,m tigr~, l~,r~ m:lly~ , d i [ ~ ¢ ~ m r/ff observ~,Sionsrepre~nt governr~.nt-Su~trame.'dloans ~,akenby ~ f f ¢ ~
appropri,atctO VJ~W]M/ff(~)--~)aS a ru~dclrnvar~,~b~e~coz'oorl~,*dngbo*d~t~r~.¢ and couatry st~'~fie eff.%-'tsaS well ,as au ~ff~: ~ ¢ 1 ~ to ~o y,'~.~L~'~'~lm~.s~' act=on cons~de~.,d. For empirical p-I'rgoses~'dt~sp,a!~:r com~, d ~ In [~,#l/(~,/-1)i~ = ,~+',r~'~+~,+'s#¢~
, ,
(12)
:~r~umpfion of random time ,-tad counta7 effects thus oorzesponds zo the va~&,t~mp~ appr¢~h which ~ bean ~ econometn~lly m the com~xt of oombhmg oross-.~-cO.onand ~ sen~ dam.,s's T]m lasttv~m ofeq. (II) is hal ob~rvabb but, ~ ~nchcatedabove, a may be ¢omidere~l minor in tho case whe~ ~ loan ts but a small fr~cuon of th~ bank's w©~m'th.~, this ~.se, one obtatm
where ]: a, E(h). ~'them is some small variation about In}~,it may be considered as yo.vtol t.heerr'ortern~with poss~ly sgveralcomponents defending oR tlme or transaafions L ~ z ~'~o(12). F o U o w m g the above chscu~ion the model m (II) ~an ~. rewrittenas L
Inr = ~ + ~
E(ub
~--ln~+~z~+v~+wu~.
= E(~,) = Z(w,,j)
= 0,
(13)
wh.'~c//~t -~/~o+#4-1a~/ The model now appca~s ia th~ familiar erroz compo~ants J~orm [Wallao~ and Hus~dn (1969)].Assuming that
and that E ( ~ ) = a., ~ ) ~- ¢¢, und E0~.~) = ¢z~,for all ~,A and t, it is thus passe,hie t~ estimate ~ , ]l~. . . . . ~ covaist~ntly and asymptotically efficiently Isle I.~ctl,ov~(t971) an6 Maddala ~,~dMount (I973) for an evaluation of Winoa,, al~,'ra~fi¢c esfi~na~ors]~ Farthe~ote, :~ is po:,s:'bIe to ¢stmaate ~,, %, and ~,,, ¢'o~;~/gufly so that some infor~mt~on oa the importun~ of vari~tzon m demand cl~!~d~' and risk prdbmn~s ~an be obl~aed.
To cSdm~tc t.he zaOdCl ~ ~,13), h • ~ s a r y to de.frame the~ xj factors w'hieh ~osKvly after: lender' Tmbj~dve cvatuat~an of de.fault probab~Jtty A~ ~ d L ~ ea~E~~, ~evu~z~x1loaa du~fi~n ~ one ~anabk' wb.~chshon~fi be ¢~Jns:deJ~'~ ~.'l ~ X v~"cor. ~=[ vbv:ot~s|y magy other factors .~|so affezt the pl,ob~o~ihty Of d~f~uI~i(or DSC), Many s,~eh economic f~e~o~ h a ~ been dis ~ C d ~ : ~ r (t961)~F~-~:ch(i951),.~iY~ell(~9G2),Cm~2m~a(1957), Bxtt~mann
230
, :
6.F#d#rand~.E.J~¢,
~n~l.V~:ofcredl~ta~:
0,973), and'Avramovic¢t aL (1964): F~rtherr~or¢, an objective and quantitative m~dy of default prohabllit/es b y F~mk ~nd Ciifie (1971)~has also indicated the s~.fistical imponano~ of a number ot L ~ o "¢ariablcs. Thas, the results o f ~lis study serve to reveal tb~ ~ t,:ntto wlnch lenders actually consider all of the ~-'tors affecting DSC in practice. N'me economic mdicatom ~re used in the analysis of whidt seven are the same as thosL used by Frank and Cline (1971). The ~Ldables are defined as much as possible l~e the ,,nes used by Frank and Cfiue to facilitat~ ~,ompzrabi~Ry of results, hence, only a brief desenption of most of the indicators ot DSC is required here The measure of non-compressible ~mports used in the prenous study, however, is not indu&.'d because the da~t for co/clfiating at wcrc not comparable ,among countries tbr aJl of 1he yea~ used and because thcoreucal arguments have been dcvelol~ which quahfy this indicator. The usual argument is that im,orfs of various consumption goods, which are not ~tal ne~ssllaes, can be c~ai~ed tcmpo~zdy so as to increase av~labihty of foreign exchange for debt ,,erectingpurposes. Tim assessment of this,factorthus rccluircs detailed data on/report composition pRttcras Morco'~er, them' may be raw materials ariam~rmcd/a~e goods that are imported for p~oducfion of demesne nonessential goods which can be reduced, hut sepamtlon of these from other intcrmedmte goods zs ns~,~ "y ~mposs~iblo Furthermore, possibihfies for mducin~¢ anpoc, s may depend hcawly cm a gove~nmeat"s internalpoliticalstatus rather than on the economic.~mporh~nce of import items. Thus, ~t seems that the notion of compressible imports may be of littleemp~rlcaluse untilareasonable approach for incledmg politicalstatus is d¢velo]~ed.a,# in the short run, debt servicing ~l~icuI~es manifest themselves as a balance-ofpayments crisis. Thus, short.zun'DSC may be studled by analyz~g the various elements of th~ bala,'~o~of payments [Avramovioetal. (1964, p. 13)].Tim most cotm~on mdlcator is 'dan debtlservic6 ratio, i.e~, tha m a d of debt service ~o export~ [Frank and Cline (1971)]. Supposedly, a h/gh ratio (indlcafing a l~cavy burden on the county's researccs) is ,zerOed'to a higher risk of'default.Irvh~e e~ al (1970) have also suggc~tcd, however, that capital inflows should b:. taken mW ~eco~nt m the shor~ run. At~hdugh uhas variable Was not consld~d emp~co21y an the Frank and C~ine study (1971), capital flows in the form of loans, gr~n~s,d~rcctinvestment% and ~mns fc:rl:,ayments'a~ nn impo~'~ut souz~ of foreign c~chaage recdl~s v~bach can be used for debt ~,~¢~ce,,Hence, h~gh~r capi~q~£nflo~ ~my be associated wi~ lower d~f~ml~ prohabili~!~,~S'To include cupid'4 in~ow.~, (,no may define a rat~o ~u~a]ogous~o t~h¢debt~:#v~ce mtm - Lo., the ratio of ,c~:bt--serdc~p~ane'n,~ to ~p~l' h~f~owa° - o r c~mb~e ~L~ two ~Itmay al~ob¢~O'.¢dthat e~s ~.,ri~h)low,gsnot ir¢~ld SI~i~'d~ by FI~211k'~ .~~ a~~q~7~), thc~th¢~coaldpossiblyb~ ~slUvely~rch~.~~O ~gz~l~~robab~sPj.
l
l
G. F ~
~
~
J~t, ~ ~,~dy~ o f er~d:t tern~
~1
l~n~ 'mod~ted dcbt-servi~ ratio' wtmre ~Jaedenomi~aator is the total of foreign exeh~mg~ earning. The latter is the appro~h u s ~ here ~~ As a balanc~ against fluctuations winch aro caused by factors beyond the cont~rol of th~ economy, one may consider fl~lble clemems m th* balance of p~mcn~J ~ x t am eantrolled by tim government v~thin some flouts. Forclgn cr.ch~mgc reserves, for instance, serve as a buffer ~ l n s t c~chaug¢ c a r n n ~ fluctuations Iu order to have comparable measures among countries, ~t ~s common ~o c~tmder a re,errs-imports ru*ao (or an imports-rcscrvo ratio). Wiflt a ]ar~r ml,~oof imports to reserves, one expects lower Dgc. AnothJ:r var,~ble suggested by Frank and Chne (1971) is the average maturity of debt (m~sured as the ratio of outstanding debt to currem amoriazation): a The)r ar~l,~u~m m dmt a predominantly long-term debt ~mphcs that debt scrvmc b u r d ~ c~-unot be alleviated ia the short mn by reducang th~ amount of borrowlug Given the di~culty of calcolatmg a reasonable measure of ~)mprcssible reaper,s i~nd the n*~d to have some mcmsure of deBcndcncy on ~mpotts, anothel possi01e variable ts the mtm of ~mports to GNP. In many devdopmg countn~ (especially those wluch have undergone an extensive proce~ of tmpo~ substitution ~ike many Latin American count.,-i¢~), a substantaal part of iraports is m the fotta of capitol and intermediate goods. Thus, the share of Lrnports m GNP refl~.s ~ d c ~ e of rigidity slnc~ a substantial cut Jn imports tmphes n constder~ abh~ lcvd of unemployment. Even ~fmostly non-e.~en~aal indasmcs ar~ a f f ~ d , unemployment is still a cost not casdy accepted. TImrcforc, it seems'~aat a highcx imFort-GNP ratto would lead to a hlghcr probabilily of default in the short run. ~9 Turmng to a somewhat longer ~ horizon, the growth of the eaport sac*or has bcel~ suggtlsmd to be an ~npormnt clement m D S C since, if the economy ~s not sta~,,t~ating, ~ts import cxpcnchturcs (and, very hkely, its debt scrwcc obhgatlons) m~ bound to increase. A growth of exports is thus neces,,ary tbr countenng th~e d(~lopments [Mikcsell (1962, p 3gs)] Presumably, a countxy w~th a h~gla ra~'e of export growth ~s less likely to default or ask for reschedulmg than otl~erwlse. A r~Lll~dvm'iabie that ¢~malso affect tl~ risk of de fault is export fluctuanons H ~ h e r c~port flu~R~.t~ou,, should ~neraily b: m,so~:~al~d wlth hgher probabi~tie!~ofu ,b,d~nce-of-])ny~len~ crlsls and, hen~, hlght:r d.~fanh probabilities Fol cxlimple, ,.t count~, cipo~mS primarily agricultural commodmcs s u b ~ t ~'WJt~: It~'m¢k~ USmlm th~ ~a~ ~, the c~rrdabon b~t~vcC'ath~ cal~italml~ow--dcbtt~t~O arm th~ ~bt-sra~,:~ ratio was 0.95. Hcn~, 11~t~o ratios ~ combined to avoMproblems *UA~al~y, t,lx~ ~z.vcr ~ ¢ ~ * ~ ' r ~ mfla,Alt~t~gh the~ ~sno p,~t-~c-Ma~r~m~on for tb.mr OA~b~a~ m~h ".~.~a~'* e2,0oi£-~a~P ~'~fio~xxyr~q~"us~t aa OFC~economywhich ts callableof
222
~. Fedarozd R.~ E~t, An.~ c @ ~ ofc ~ t terms
t~ ~etiodi~d ¢ao~ faihm~ ~la!/b= ~gardt~l a~ ha~rlng a lower .DSC, eeteria pat Ema.Ah~r (~Q6])hat sug~e~d that e~o~: fluctuations shntfl.d ~ ¢~cuL~tcd around a ri ,stag t~and s~ncc ~'q~o~ grow~ is ~ dL'drabl'~ indle.~tos. Tb-~sis the approach taken aere [see) also, Frank and Cihm (1971)]. In the long run, ~t Ires besa m~,,ued tha~ erie of the most importam £actors affecting DSC is the growth ofp~r capit~ dolv~'tl¢ product. 2° Tim is ~ factor, however, not comldcred by Frank and Clin¢ (197~). TI~ ~nderlying ass~pfion is that t ~ hmldng factor m t ~ long run is t.~) savings ~ap. Increased per ~pita output provldes ad&t~onal resources for bo~ d~bt ~ r v J ~ ~nd ~ s ~ d coasumpUon, h is usually assum~t t ~ t ~ processof ,~owth is ~mchthat expo~ sapac~ty is increased both fimo,'-gh e~paasio~ of ~ e tradi~oua'[ exports sector and by developing new indm~n~s producing ~o~export or producing maxke~ble goods wi~ch can be re~rect~d ~nto export c,~aanels. H ~ , one wnu~d ~p~c~ an ,.reproving debt mrdciag cap~]ty and a declininst probab~hty of de,'unit. Another mdic~lor whmh hm~ b ~ n sug~;~t~:l by Hanson (1974) is tee debtcapital ra~o. The underlying cxpi~uataon ~ ~h:~t th~ totat b n r ~ n ~v~r ~ long perlod of dine ~scompared to ~ ¢ overall productive eairacity repre~nted by the stock of capital, tt is ','bus a rather stat~ mcasm~ smo~ growflx oi" capital and debt ts a~samed e q ~ . '~z For l~r',,.cficalpu~osm, howe'er, it would s~.~ thut GNP should b~ used rather ,th,rm capital *dn~: in~-UionM compm2son ¢,f sap~tal s'iocksm y no~ always M m~tinLffUt, L~.) the productivity and q u e r y • ar~ not ~dways com~asabl,. A hig~'~" vah~. ~)ft ~ debt..~vP raho is ex,t)e~,~ to indicate a h~gher probubility of defattlL An additional factor whidt .'.~ayaf[~'t elther , ~ r t - n m or long-ran DSC is level of l~r capita income. Th~ a~gument ~ : u is that a h~gher l~vel of income .~mphes h~gher levels of non.nssenIial ¢o~st~tpdea (both ,pfi~ate and public). This allows the govctmue~,t more fle~Jbdity ~tt mrms of reh,.aslag resources for debt ~r~xc~ paymems ~md henc~ a lower pr(~:Oabdityof d#'£a~t. 5. EmpL~ieal~x~s~I~ The World Bank pub~l~es qt~rte.fiy data on pub~-icL~d ~Enroenrr~-'~, tran~,¢tmn.q. To estimate t~o mo~cl, 102 oos~'~fious o= p~,bhc an~ ~ub~eIy guaraut~l team fwvoIv~ng2/c~untr~es m'~,used for d:z d ~ t qaar~e= dufi:~3 1973 and i97~ 7 " ~ e ob~tvaNo~s .;ucI~de inte~e-~ m ~ ~ d ~.os,n damt~ou. Data for calculation ~:~f0 a~ ]pub~isI~'Jby '~m~MorS'~m G ~ : ~ t y T,~,;L D~t~. for '~.~edcmrndaan~ o! D S C ~,xe aw~a]ab]s i~ pub~.~tions of tI~ World ~:~a~, ~te~mfieu~l Monetary Fund,. arm '~h~U~l~ted~a~Jous a~d .~rc dx~c~sr~ ~a
~. Fcder and.RE. J ~ , An ¢omlys~z o f cre~++ter~r
~
det~dl by Fede~ (1976). The underlying assumption is that ba~kers use t h ~ IndJc~tox~ to evaluate the probab~ty of default ~n the short run, ,'roda duraUo~ factor ~ used to generate long-run probab[li~y under the assumption of approx~mainly constant sho~-run probab~Iity. Alter'natively,one may hypothcmzc that ;~m lender artctapts to csuina~c dzrecfly the overall probebdi~y usmg both long+ ran a~d short-~n Indirators and incorporatmg the dureuon N to account for ,[ower x~abdlt'y of loath-run proje~hon. ~ly way of summ~y, the rune economic m&cators used m the present study arc (I) the modified debt-servi~ raao (whach mciudes both ~..xpot'tsand cap~t~.l' ~ ows), (2) the dcbt-GNP rauo, w]uch ts an apprommaUon to ]Hnnzou's (1974) dzb~--t~pR~ ratio, (3) an exports ~uctuaUoas ~ndex,, (4) projected ex.potts grox~¢~ ra~o, (5) th~ amortmaUoa-dcbt ratao, 22 (6) GNP per ~.plh~ (7) the ~mport-ONP raCao, (8) the ~mport-zcscrves ratm, and (9) projected GDP gre ,vtlb rate. In addltaon, loan duration was conslde~.d as an explanatory vanabi~ hs ¢ ¢ ~ . n ~ ~Eould ~us reflectthe pure rlsk effc~t of loan mr~tunty Um,ag the at~ove defwm~ons for ~be x~ vartablc~, the ¢quatzoa m (13) was cstlmctted w~th the foHowmg error components approach F~rs~, c~t~mates of fl~, flz, , #~ were obtained by orchnary least squares usmg ~,lummy vanabl~ to reprcr.~:nt the tm+e (v~)and country (u+) effects; h~uc~, es~m ttas of the v, and u, were also obt~nsd as c<~$c~ents for the dummy w,,.zaabl~,. "['h~nc~uma~s of a,,;rodcr~were obtmned by eompu~ng the sample vananc~ of cstu,Uatc~d u+ and v~ T ~ estimate for a~ was based on the t~sadual sum of squa~:s, U s m g cst~mat~ fo~'¢,,,¢o, and c~, and erro~ cov~a'~c~ matrix was tJ~n astlma~d and used m coml~at~ng g~nerahzcd Icast-square~ estimates. This ts the method which was found[ to be superior for error components c~t~matzon by Nerlov¢ (1971) wh~.~n lagged endogenous variables am prescnL Although there are no ]agge,d endog~nogs variablesincluded e.xp1~c~tlyin th~sstudy, surge ofthe,:xo~ons variables m~:~y ~ influenced by perc~vcd D S C m pre~..d~ng)'cats In ad&uon, Maddala t~d Mount (1973) have also found tha~ this two-stage method and a number of o~Iel aIL~raa~w two-stage estlra~tes ate about equally sup¢ nor for error compone~ts cs~nmt~on w~thoat la~?,~.,edc'~,dog~.,nousv'~rmbles Furthermore, as ~d/Jm~t,~d by Ncr!ove (t971), the method ~z~,.'dhere is th~ c ~ t way to ~.~,t+re ~I pcl.~i~veva:dan<;-~,comr?one~t ~t~ma~:~ in the ~mbalanccd block ~.~ 2~ 'ThP:resalt~n~c~I~mates (m~d corre.~pon~g ~ n d ~ d ¢r~'ots)for the unobv~ vubl~ Ip~r~me~e~s ¢,f th~ model £n (13) a~e pr~cnted m ~abl+~ ~ ~+ [n c~c l ~11
cs~maZ~s h a w t i e ~ t : ~ A s ~ , but the ~uort~za~on--
Table 1 Rc-~ccsmonresultsfo~ l~e E~omazkct mo~.l, 1973 lind 1974." Vamabl,
C.as~ 1
CcSe 2
C~ts~3
Consent Loan duraUon
-3.5702 0.0559
--3.5730 0.0559
--3,5~63 0,0563
Mod~+A debt-~clv~ rat~o
1,2771 (s.H5~3 0.1057 (0,6~04) 0.1842 eL0080 --0.01~ (0,0127) ,-0.0001 (o.~zO 0.5735 ~'2.~Z~) 0,0252 (2.6692) - 1.2722
D e b l ~ l ~ mt~o
)~tlbor~J,fluctuat~oasmclcz e~TlOr~l/~t,ng-~Cbt Y~c~iO GNP l~c capnta Imporir.-G~-*,tPmtm .Vmporl~,l'~'vcsratio Prol~x~ G D P ~ h
~.2743 0,.870o) 0.1076 (0 ~ 9 ) 0A858 (LO~8)
M C ~ v~ac
ia sm~ple
9.353
L3115 ~o2,~o) ~'
0,096 (o.o~) 0~'~77 (0 039) 0.1892 0.62) (~.~S) (o+o41) 0,~.~ (C,O01) -o.ooor - 0.o~1 62~,0 (O.~.~gD (zA138) (Y~i4.O) 0.5718 0.6718 0.2~8 ~4073) 0A950) , (o,o~) 0.0~'2 ' 0.~237 3+155 , (2.6838) (2.6084) ($:.$36) -L2751 --1.36:/6 O,O&l,
,¢~r~znccsof d~,laale ~ivcn L,I~llhc~J, ~Bl~nlt~,~
a "v.5 percent level 2s I t can ,,tlso be ,~Iotcd from ~ e ~ympl:a~c F ~es(:lL,xt the mmuIItaneou~ly ~ r o ~ o t ~e ~+~jec~.L ~ul b ~ u ~ ,0t"~h~ I sycnploti~ r~ure of tbs~ i~a~, on~ is re~.u~r~'tio use so,ely ~ r ~ l ~ of om~ ~ e or P~othk~,£.
G, Feder and .R.F. J~r, An ematysfx of credit trrrr.s
235
es't~rmtes for the sta~asticelly important waxiabIes change very httle when the insi;paifieant variables arc "excluded.ze On the barns of these resldts, It may be concluded that at least six economic indicators seem to be related to DSC: (1) the mochfied debt--servlee ratio, (2) export fiuatuat~ons, (3) the maports--reserve~ reao, (4) the lmport-GNP rutao~ (5) GNP per capita, and (6) pxojected GDP gro~ th While the first four of these varhb]es may be consdered as short-run inventors, the last two relate to the longer run. This ~s consistent ~lth the fact that most of the transaction. included m tbas study are w~tlun the range of 7-I0 years, wh,eh may be cons~de,'ed long enough for lenders to aT to project over~l development m the economy rather than samply the growth of the export see:Lot. Exportr,. however, are co.side.red important tot shorz-ru:~ ask eva!u=uon ~, reflected in the debtservice rauo and the export fluctuattoas index As for the lenders' underlying ibehavaor, ~ e re~ults may support the suggesuon that b~nke~ try to estimate the overall orobabthty fro, the full duration of the loan) ~ther than a short-run pz~,hahd~ty wtuah Is then assumed constant for e.~eh year. The outcomes al~o corlfirm the hypothe~s that loan duration ~as a pure (poslt~ve~ risk effect on the probabd~ty of default az perceived by the lenders. 6. P~ree]ved DSC fm~ae EnredeIlar m=r~et ?eree[ved (or subjective) prohabdltics can now be esUmated exeapt that flo ]s laot identified {otdy p~ = flo+/L+l~ Is ~umated). However, :forte considers various hypotheucel constants, some insights are possble since the ordenng of probabiliues is not affected by arbitrarily changing the constant. Table 2 pre~uts e~tamates of the snb.leeth'e prohabihue~ for |he 102 obsexvut~ens ~ath several hypothetical values of flo. It seems reasonable to expect that the subjective probab~hties wdl not assume very high values since in t~at ~ the interest rote ~sproI ~blyso hzgh as to deter tJa~. potenti',.d borrower. In this case a constant term between -3.25 and - 2 i n ~ i c e ~ an a,,'era~ prohabdlty or" default from less than 0 1 to over 0 2 AI,tL~ot/~ the ~ m a t e d s~,~bjectlveprobabihtles do not include any extreme v~lu:s, there Ls s~l! considerable va~a~aon One ~ n show that the model p~zu~ed ~n ~ . f~%t p ~ of *~s paper amphes I~gh sensittvity of the interest m ~ n to s m ~ vanz.~nns m ~he prohablh~es, especially when the prohabdlues ~ c relat~vely ~ow. Courtier, for ,~ust~nge, the case of r~k neatralrty ~ud[ suppose ~t~t, ~br n borrower with probab~lily ~£def~mt: equal to 10 percent, ~he m t e ~ t m a r ~ ~ e ~ O.SOof t percent. Svr;p0se now that the prob~Sfilty racreases to ~5 percer~ v/a~c ~2 r~e other er,em~t~ remzln constant. 27aea, using equation vanr.b~ ~z~ r ~ o n ~ i ~
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(10), the new immest margin becomes 1.27 percent. This is an i n c z ~ of m,>re titan 58 percent m the intcllxst margim )'n general, the d~ficity c f ~ . ~ ' t m~lgin with respect to probabd*tZ chan~gesis always morn ~azauun~rf (for ttz, c~ae of risk neutmhty) since dlffe~:ent~afi~gthe Iogaslthm of cq. (10) obtalns d r 2~ dP r
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P~mIlh~g the de~/~on of ~ , it ~s cvldent tb~.t asmlmptioas ~boul ~o have implications for demand classify and loss rat~. These ~mpl~*~a~o~s can be e~,aramed most easily under the assumption of/ask ncn~mI~y Which ~ bce~ argued to hold as an a~pp~oxlmation. In this c.'~se,~ =/~o+In~i+# where/~ h the expectation ofln[r//(~--I)]in the sample. If average loss rate ~ ~s about 0.I0. then the case 3 ~:~mate o f fl~ ~mphes that ~*= - 3 . 4 6 3 - f l o - I ~ ( 0 . I 0 ) = - Lo~37-~o. Hen e, m the, = k ~ of Hs~ neu~zahty, it is not masoae~ble to co~ '/Ier #o > - 1.23 smcc that corresponds to ,a < 0 and thus impI~es a pos[fiveJ,y d o ~ demand c~rvc. On the other ] ~ d , ~o a~Jy ~'ghdy less tlmn - I . ~ 3 co~re~oa& to large r~0 c., very chlsdc msidu)fl demand). Finally, as/~o l~¢ts l a r ~ ~u absolute val~e, (he imphed d~mand eIa'~tid~y contlou~s to decline towa~l q = I O / = 1.1556 at flo = - 3.25). ]~as~d on the vamlace compoaen~ csfima~.cs,c¢'~eral corii~I:t.[oaa]coaclas~oas are. poss~ble, Th~ v~dane= c~mpoz~ms esdmatc~ for cas~ 3 :ia t~ble I (which a ~ apprommatdy the sa~mcin ¢ a ~ I and 2 ~so) ate)
t,.e ~o :xp~.~ned di.~t~r~ane~s. ~u~ ~ th~ context of ~ model oftt~s ~9~r, ~ y cu%'e.lc~ m countr~,es arc due to d~'cr~ng demaa¢~ eJ~t~c-~ti~, difl'cr,~ngIo~
~urodollzr markeL Tcchnlcally, however, these s,'n~e obs~'wlaons would also be possibie if residual demand were h}ghly clasuc but perceived loss rotes were quite d~Ecrcm for different countr~. Differing n.~k attitudes (alone), on the o@~r hand, cannot le~l to t t ~ e results u n [ ~ risk attitudes (of the negotlatang bank) vary systen~o.dcallywi~ tlm country, i.e.,a country tends to obtain all o.r its loans from the same bank.
~ is .,nt~resfi~ to compare ~hc estimates of lender's" subjc~-~ve det'ault probabib~es w~th the rcsul~ of obj~'t~ve ~tud~cs w~¢h have attempted to estimate t,~e default probabflm~s. Objcct~v~ s~dms of default probabdit~es h,~ve been made by Frank and Clme (197D and by Feder at~ Just (1977).Comparing w~th th~ results of Frank and Cbae, ~t appears that m:~uy more in'¢k~,~torsare its, corporaU,~'d m the ;ub~ccave probab~ty tlmn anmally ba~e a significant effect on defau|~ probabdlt'y;thor resultsmdi~xttcd the objective nnpormucc of only the debt-se~ea mile, the amomzauor~-debt muo, and possibly the ~mportreserves r,~fio. However, tholr smttsucal s~Eni~Rnc~ tests wcrc applied moot ~.cfly m conel~ding the ms~gmlicancc of other variables; and several potcr~tmlly ~apo~*~.~t v,,anablcs were not considered. Using at least a~ympU~t~calIyapphcable smfist~cM t¢sts, the Fcdcr and ~ust stady ~ndic~c~ the .~gn~cant importanc, of at least ~'¢ mchcators m the objective ~sdmafion of default probabilities. TL,=sc include the debt-service ratio, tl~ i m p o r L s - r c s ~ farm, GNP per capita, the ~pit~tl intlows-dcbt scrvic, rode (whmh ~s combined vnt ~ .~e dcbt-.~rvlc~ ratio to ibrm the modiRed dcbt~smwio~ ratio m tim present stud~, ~ d (ahhough less signifi~nt) GDP growth. 2~ All th~se variables appear important in the s~bje~ive resultsas well (table i). ~c~uso of th~ meth~,d of analysh (d~s~dmlnant analy~s) used by Frank ,and CLio© (1971), no estimates for ddauR probabfliues arc p~ble; but the Fader a~td 3u~ study uses lo~itanalysm and hence allows the objectivecs~mataon of d~au~t l)robnb~liues f<~rthe same ~ o f ¢L..~used ~n *.he presem subjec~zve stu, ty. TSe~ ~e;,ultsc~anot be rcr~.~,cdhet~ bc~mu~e of theirIcn~d~mess, but the dff~:ran~-----'s~ stnlun~. U~ng ~bz obj~ttve model, csmuat~d default probabfl~Ues from less tha~ 10-~ to mere *.hag 0 99. Ex~'pt for four coimtnes, the et,fim:~t~ are ~l I ~ thai 0.~)i ~l~tb2 e ~ m a t ~ v f lenders" subjeauve probab~hucs, h o ~ g e r , if~eo is adjusL~d so t h ~ some subjc~:i~eprobabilities~ e in the ne~gkb~ood o£0.,91~ tI:c~;~I subjcctwe probabdivj esumates f~l under 0 1 T h ~ ~,S~m to be coe,*,~t t ~ ~ c~t~ciz~ by I~ow~.xd(lg7 2) and von C ~ m (X~)Tt), ~f~.2~C'to tL* q:x~'Ry of risk :maIyg:u ~n ~he Euromarket
, .... : , , ~,, .... , , ...... ,, ,,,,,I , ,~ T ~ e ' i n ~ ' t au p ~ h used m t.~,~study, ~s has ,od'on the nohon that the pro a~illty of default is one of tl~ factors entering l~ders" decls~om regarding the term> of credit to be c~rged. The xno~el describes, the va,~ious'¢len)ents ~nvolvod in the de~rm~atlon of the r~te ofinterest wi~, special reference :~oprocedures of the Eurom~keL It yields an equilibrium relation between the ~,terest raargm and the probahiilty of default which imphcs higher interest for ldgher risks. Other factors which ait'cct the interest marg~tt are the elasticity o f residual demand for lo:.~s, the locreeiwxl rate of loss related t o default, and an extra premium due to riskaversion,~atb.e~.zr¢ of the lender,
Assuming a log~ts ~ . ~ a o ~ for the ~latlon beW~e~n the probabilityof default and ~ d o u s economl,~ i~'hc~tors, the equahL~iam relation betwc~u the interest m a r s h and the probability, of default w ~ then tl~J~stbrmod into an ecou~rnetrie model. The parameters of tic model were c~'t/mated using Euzom ~ k ~ dam on publiclyg~t~Lr~nteedIo~us. Rcsuhs suggestthat slx econon~c indicators slgnifica~tly ~ e c t ~en~rs" subjective ]~robability: (I),the modified debt--service ratio, t2) income per'capita, (3) the, projected rate of growth of GDP, (4) the import~re~erves :a~o, (5) tlt¢ share of amports m GNJP,~ana (6) export flactuafions.~a t~dition,it wa~ ¢onf~rmod ~mt ths'~atunty term of the loan has a positive ~,,ffccton ~ e subje~-'tiveprobability of default. Using the ~ m a t e d coet~ci~Ints, :endsrs" subj~ctiv~ probabilldcs were also estimated for cac~ spcci~e tma~ ¢~don observed..Compsxing ~ t h objc~.Civemeasurements of default probabilities, it ~appea~, '~L~t'soroe nmprovements'.in lenders' subjectivo probabilities are (~os:tibla. ' . .' . .' ' . ' ' . .' Finally, the results of ~his study suggest s6me ~nteresdng possibilities for pahcy formulationin borrowing couutdea.Increasingly,d~elopit~gcoantrles ar* entering conL~ierc~ulcapital markets for funds; add, of course, the av~i|~bifityoftl~e fu~dsd~¢ud~ on how lenders~e1~:~ive'the.~ DSC. The eonttoll~i regular;onof im~,~ortantD S C indif~torslcanthusbecome an ~mpoz~antpartof government poFcy i,. reaching many national ob~c~vcs ~ e ct al. (1970), Hansoa (1974)},A stud:~of :h~.~ poli*/'-rclat~dL~sucsb,~s~Ireadybegan and ~qcur~.'vtly bei'~g ckpssdcd by the antLer. ~ut the fotthcomlag t~ults witl bc trusted in ano'~er pal~*. '
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243
I ~ . and P,.M. Cye~ 196S, T ~ r y of the firm. l ~ u r o : a]locatJon m a marl-et economy (Prent~e-I-l~L F _ , ~ l ~ r ~ Cliffs, N.D Cox, D., 1970,The analyss of binary,data (Mcthuc~, L~mdon). Faadand, $ , 1967, C o n ' t r ~ on Mr, G uh~u's paper, m: LH. A~cr, ed., Capl~l m o ~ t s nnd o~onomz: developmem (St. Martin's Press, N¢'w York) 26t-264 ~ G , 1976, Default risk md~=tors m mterr~nt:o:~lborrowing, ~publt~bcd PE.D dls.sert~tton(Umversily of {~xkfornm,~k~rkclcy,CA). Fcd~, {3. and R.E Just,1976,The Etu-cdolhrm~kct: A thce~,'Jcalamdy of lemhng under deleattltrisk,Working Paper N o ~0 Umv~slty of C~iform~, Department of Al~cuhura] and Rcsom~ Ecoaom~, Berkcb,:,CA) Fe~cr, G. m~d R.E. Just, 1977, A szody of t~:bt servicing cavalry applying Io~1 anMys~s, Journal of I ~ l o p m c n t Economzl~, fottl~commg Fn~h, D., t951, Invcsm~at servxce of und¢,Mevelopedcotmtrtm, IMF Stuff Parers ltl, fJ0-$5 Fr~tk, C.R. and W.R. Clme, 1971, ~I~uremcnt of debt scrvtcmg ~ a l ~ t y . An a~,phcat~on of dlscnrnmant nn.dysxs, Journ,.d o"I~t~rnattonal F.conom~cs 1,327-344 l~zrth, J,H., 1973, I~teR-nnt~onn|doffar ~lqtudtty av.d the Euro-dol]ar mRrkct, De Ec~r~m~$t 121, 347-361. Gulhau, P~.L, 1967, 'I'Ve ~ for fco*~n r~ourccs, a~orpove c~pat~,, and debt l~r~ ms Cal~Clty, m: J.H A~lcr, ed, CRr,lud rnov~n~ts o ~ cconorm¢ development (St, *.~arhv,'s Pre~, New York) 24O26O Hamon, ~A., 1974, Optima! m|e~'n~u0nM borrowing and lending.. Amer,~m l~t~oncrmc Review I . ~ , 616-630. Hewson, 3.1~. and E. SMmk~b~t.w.1974, The Eurodollar depos~ r~,.~up]~er A por~k~ho approach, ]MF Staff I ~ e , ~ 2Y~,30T-328 Howard, p., t97P. Med~-~mm hnd~, lead ma~agta~ and medaxm-t~m t,oma~, Ee ow31~ey, 18--2L Irwne, R.J., y . ~V..~'om arm H . F Loe, 1 ~70, How to ~ r ¢ ~ succe~,fu]]y, Co~rnb~z ~,~ar ~al ¢ ! World ~mm~,3 5, 42-48 y ~ t a ~ c l x ~ . C.P., 195~;, Ee~n~mm de~le]opment ~3M~raw-H~IL New ~/or~ 260-27 '~ Levln, J.H., 1974, The ~ r ~ , l a r market and tae lnte~attomal t ~ e ~ o n of t ~ e ~ r ~ s , Canad~a $ o u r ~ of ~¢~,~omk* 7, 205.=.,24.
Ma~dala, G.S. ~ad T.D. ~0o~, 1973, A comlx~,m~..~s~ad~yol a~iv:rt~n~ ~s~J~.ids ~r S~/Asscci~on
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