TAILIEUCHUNG - Bonds or Loans? On the Choice of International Debt Instrument by Emerging Market Borrowers

The issuer sells bonds to capital market investors and the proceeds are deposited in a collateral account, in which earnings from assets are collected and from which a floating rate is payed to the SPV. The sponsor enters into a reinsurance or derivative contract with the issuer and pays him a premium. The SPV usually gives quarterly coupon payments to the investors. The premium and the investment bond proceeds that the SPV received from the collateral are a source of interest or coupons paid to investors. If there is no trigger event during the life of the bonds, the SPV gives the principal back to the investors with. | Bonds or Loans On the Choice of International Debt Instrument by Emerging Market Borrowers Galina Hale UC Berkeley This version November 14 2001 Abstract This paper analyzes the access of emerging market borrowers to international debt markets and specifically their decision of whether to borrow from banks or on the bond market a decision that does not appear to have been analyzed in the literature before . This choice is modeled using a framework that focuses on the implications of asymmetric information. In this model monitoring by banks can attenuate moral hazard. But monitoring has costs which cause the bank loan market to dry up faster than the bond market as risk and interest rates rise reflecting the presence of adverse selection . These are the factors that drive the borrower s decision between bank loans or bonds and that determine whether high risk borrowers can access international markets at all. The model predicts that borrowers from countries where economic and political risks are highest will not have market access. More substantively it predicts that borrowers from countries where economic and political risks are somewhat lower will issue junk bonds while those from countries where risks are still lower will borrow from banks and that borrowers from the lowest risk countries will issue high-quality investment grade bonds. A censored regression model with random effects estimated using simulated maximum likelihood supports these predictions and reveals the variables that affect the choice of debt instrument at each end of the risk spectrum. JEL classification C34 F34 Key words emerging markets international debt censored regression Department of Economics UC Berkeley. Contact galina@. 549 Evans Hall 3880 Berkeley CA 94720. I am grateful to Barry Eichengreen for guidance and encouragement to James Powell and Paul Ruud for help with econometrics. Bronwyn Hall Chad Jones Richard Lyons Maury Obstfeld David Romer Mark Seasholes Kenneth .

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