Hilscher and Nosbusch’s paper* focuses on sovereign credit spreads of emerging market countries. They find that countries that export goods and services that have greater price volatility have much higher borrowing costs.
“Countries that have riskier income streams tend to have higher borrowing costs—they pay higher interest rates: it's a simple idea but it had not been looked at by the academic community,” says Hilscher.
“We started studying this issue back in 2004, and it’s become very relevant now because of the European sovereign debt crisis. It is also related to an ongoing debate among economists about whether global factors, such as aggregate risk aversion, determines borrowing costs, or whether local and country specific factors are more important. Our research indicates that country specific information matters more, which is consistent with current market conditions where Ireland and Greece pay much higher interest rates than Germany and France.”
Take a country such as Venezuela, which is one of the world’s biggest exporters of oil. A barrel of crude oil today trades at about $82, but two years ago it traded at more than $120 a barrel and ten years ago it traded below $20 a barrel.
“Those are a enormous price differences—a bank would naturally say that a country that earns most of its income on a product with such a big variability in price should have to pay more to borrow,” says Hilscher. “This is standard in corporate bond pricing: banks look at stock market volatility to establish borrowing costs, and those companies with higher volatility tend to pay more in borrowing costs than really stable companies. Our analysis proves that the effect is also present for sovereign debt.”
The Review of Finance, which is the journal of the European Finance Association, awarded three prizes in its annual contest for best papers. The journal’s advisory board and editors chose the winning papers among those published in the Review of Finance in the previous four editions.
“It's certainly exciting to win this prize,” says Hilscher. “Our colleagues who were also given awards are leaders in their field, so we're in very good company.”
* Determinants of Sovereign Risk: Macroeconomic Fundamentals and the Pricing of Sovereign Debt by Jens Hilscher and Yves Nosbusch, Review of Finance, March 2010
The entire paper can be found at: