Risk, Contract Terms, and Maturity in the Sovereign Debt Market

Abstract

ABSTRACT In this article, we examine the relations between risk, the choice of foreign or local contract terms (parameters), and maturity in the sovereign debt market. Our primary finding is that the maturities of bonds that carry a meaningful degree of risk are greater when the bonds are written under foreign parameters. This finding is consistent with the Credible Commitment Theory. Relinquishing certain key contractual parameters (governing law, jurisdiction, currency, listing) precludes the issuing sovereign from taking actions that would diminish the wealth of its bondholders after the bonds have been issued. Correspondingly, the yield on lower-grade bonds, written under foreign parameters, is less than the yield on bonds written under local parameters. Investors are willing to pay a premium for lower-grade bonds if they are written in foreign parameters. Finally, we find a positive relation between maturity and S&P ratings for the subsample of lower-grade bonds. However, we find no such relation for the subset of high-grade bonds.