Property Rights and CDS Spreads: When Is There a Strong Transfer Risk from the Sovereigns to the Corporates?

Abstract

When a sovereign faces the risk of debt default, it attempts to expropriate the private sector. But the likelihood of a transfer from the sovereign risk to corporate default risk can be mitigated by legal institutions that provide strong property rights protection. Using a novel credit default swaps (CDSs) dataset covering both government and corporate entities across 30 countries, this paper studies the strength of the transfer risk and the role of institutions in mitigating such risk. Wē nd that sovereign risk on average has a statistically and economically signi¯cant in°uence on corporate credit risk. All else equal, a 100 basis points increase in the sovereign CDS spread leads to an increase in corporate CDS spreads by 74 basis points. The sovereign-corporate relation varies across corporations, with stateowned companies exhibiting a stronger relation. However, strong property rights institutions tend to weaken the connection. In contrast, contracting institutions (protection of creditor rights or minority shareholder rights) do not appear to matter in this context.

Sovereign to Corporate Risk Spillovers

“…The external appendix contains two additional tests that are not directly linked to a channel: first, following the evidence in Bai and Wei (), Table A‐4 confirms that our results are stronger for countries with weaker property rights. Second, Table A‐5 documents the existence of a sovereign ceiling (Almeida et al.…”

“…The interest has shifted toward developed economies with the onset of the European debt crisis. Bai and Wei () study the sovereign–corporate risk transmission and argue that the correlation between sovereign and corporate spreads is stronger in countries that have weaker property rights as well as for state‐owned companies. Lee, Naranjo, and Sirmans () show that companies can decouple themselves from sovereign risk, either through foreign investments in countries with better property and creditor rights, or by cross‐listing in countries with more stringent disclosure requirements.…”

On the International Spillover Effects of Country‐Specific Financial Sector Bailouts and Sovereign Risk Shocks*

“…We measure the sovereign credit risk for the i th country using the 5-year sovereign CDS spread. In line with the CDS market conventions outlined by Bai and Wei (2017), we work with US-dollar-denominated CDSs in all cases except for the USA, where we employ euro-denominated CDSs. In addition, following Bai and Wei, we use CDS contracts with a complete restructuring clause for each sovereign.…”

“…The index for country i is computed as an equally weighted average of the single-name CDS spreads for locally domiciled financial firms that satisfy a set of selection criteria inspired by those used by Acharya et al (2014). Specifically, with few exceptions, firms must: (i) be listed in the Markit CDS database and have USD-denominated 5-year CDS spread data that accord with the corporate CDS market conventions documented by Bai and Wei (2017) and that cover at least 10% of the sample period originally considered by Greenwood-Nimmo et al (2019a), which closely maps onto our sample period but at daily frequency; (ii) be classified by Markit as financials; (iii) be classified as either banking or insurance firms in Bureau van Dijk's Osiris database; (iv) be identified by Markit as operating in country i; (v) hold assets of US$10 billion or more in at least one year between 2006 and 2015; and (vi) have publicly traded equity. 10 Overall, data for 137 financial institutions are used to construct the aggregate financial sector CDS spreads that we use in estimation.…”

Exodus from Sovereign Risk: Global Asset and Information Networks in the Pricing of Corporate Credit Risk

“…Borensztein, Cowan, and Valenzuela () examine the relation between corporate credit ratings and their sovereign counterparts using S&P credit ratings on 509 firms in 30 emerging market countries. Bai and Wei () study a similar topic using international CDS data from 30 countries over the three‐year period 2008 to 2010.…”