Credit Risk in G20 Nations: A Comparative Analysis in International Finance Using Option-Adjusted-Spreads

Corporate bond yields are the manifestation of the cost of financing for private firms, and if properly evaluated, they provide researchers with valuable risk information. Within this context, this work is the first study producing corporate yield spreads for all S&P-rated bonds of G20 nations to explain their comparative riskiness. The option-adjusted spread analysis is an advanced method that enables us to compare the bonds with embedded options and different cash flow characteristics. For securities with embedded options, the volatility in the interest rates plays a role in ascertaining whether the option is going to be invoked or not. Therefore, researchers need a spread that, when added to all the forward rates on the tree, will make the theoretical value equal to the market price. The spread that satisfies this condition is called the option-adjusted spread, since it considers the option embedded into the issue. Ultimately, this work investigates the credit risk differentials of S&P rated outstanding bonds issued by the G20 nations to provide international finance professionals with option-adjusted corporate yield spreads showing the credit risk attributable to debt instruments. Detailed results computed using OAS methodology are presented in tables and used to answer the six vital credit-risk-related questions introduced in the introduction.

DEFAULTABLE TERM STRUCTURES DRIVEN BY SEMIMARTINGALES

In this paper, we consider a market with a term structure of credit risky bonds in the single-name case. We aim at minimal assumptions extending existing results in this direction: first, the random field of forward rates is driven by a general semimartingale. Second, the Heath–Jarrow–Morton (HJM) approach is extended with an additional component capturing those future jumps in the term structure which are visible from the current time. Third, the associated recovery scheme is as general as possible, it is only assumed to be nonincreasing. In this general setting, we derive generalized drift conditions which characterize when a given measure is a local martingale measure, thus yielding no asymptotic free lunch with vanishing risk (NAFLVR), the right notion for this large financial market to be free of arbitrage.

Mind the (Convergence) Gap: Bond Predictability Strikes Back!

We show that the difference between the natural rate of interest and the current level of monetary policy stance, which we label Convergence Gap (CG), contains information that is valuable for bond predictability. Adding CG in forecasting regressions of bond excess returns significantly raises the R2, and restores countercyclical variation in bond risk premia that is otherwise missed by forward rates. Consistent with the argument that CG captures the effect of real imbalances on the path of rates, our factor has predictive ability for real bond excess returns. The importance of the gap remains robust out-of-sample and in countries other than the United States. Furthermore, its inclusion brings significant economic gains in the context of dynamic conditional asset allocation. This paper was accepted by Gustavo Manso, finance.

INFORMATION FLOW BETWEEN THE US DOLLAR-RUPIAH EXCHANGE RATES

This study investigates the information flow between non-deliverable forward (NDF), spot, and forward US dollar–rupiah exchange rates during the post-Quantitative Easing (QE) period. Our results show a unidirectional information flow from NDF to the spot and forward rates in the post-QE period. We also find that the Indonesian government securities (IGS) played a vital role during the QE period, while international reserves preceded the US dollar–rupiah spot, forward, and NDF exchange rates post-QE. Hence, international reserves became an important policy variable in managing the currency value. Our finding redefines the role of IGS as a policy tool. As a policy suggestion, the Bank Indonesia should maintain a sufficient amount of foreign reserves to mitigate foreign exchange risks of the rupiah.

MOMENT APPROXIMATIONS OF DISPLACED FORWARD-LIBOR RATES WITH APPLICATION TO SWAPTIONS

We present an algorithm to approximate moments for forward rates under a displaced lognormal forward-LIBOR model (DLFM). Since the joint distribution of rates is unknown, we use a multi-dimensional full weak order 2.0 Ito–Taylor expansion in combination with a second-order Delta method. This more accurately accounts for state dependence in the drift terms, improving upon previous approaches. To verify this improvement we conduct quasi-Monte Carlo simulations. We use the new mean approximation to provide an improved swaption volatility approximation, and compare this to the approaches of Rebonato, Hull–White and Kawai, adapted to price swaptions under the DLFM. Rebonato and Hull–White are found to be the least accurate. While Kawai is the most accurate, it is computationally inefficient. Numerical results show that our approach strikes a balance between accuracy and efficiency.