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This paper assesses the consequences of implementing a joint liability debt system in a two-country small open economy model. With joint liability a default of one country makes the other participant liable for its debt. The results highlight a trade-off between the contagion risk, in the sense that this instrument may push some member states to default even though they are individually solvent, and cheaper access to credit on average, since lenders are at risk only if no participating sovereign is willing to service the debt. The findings suggest that the welfare consequences of this policy proposal hinge critically on the timing of its introduction: Introducing such instruments at the peak of the Eurozone crisis would have helped the Periphery and harm the Core member states, while its adoption during normal times has the potential to make all participants better-off.

Capital Markets --- Debt Markets --- Default Risk --- Eurobonds --- Finance and Financial Sector Development --- Investment --- Joint Liability --- Public Sector Development

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This paper examines time-series and cross-country variations in default risk co-dependence in the global banking system. The authors construct a default risk measure for all publicly traded banks using the Merton contingent claim model, and examine the evolution of the correlation structure of default risk for more than 1,800 banks in more than 60 countries. They find that there has been a significant increase in default risk co-dependence over the three-year period leading to the financial crisis. They also find that countries that are more integrated, and that have liberalized financial systems and weak banking supervision, have higher co-dependence in their banking sector. The results support an increase in scope for intra-national supervisory co-operation, as well as capital charges for "too-connected-to-fail" institutions that can impose significant externalities.

Access to Finance --- Banking crises --- Banks & Banking Reform --- Debt Markets --- Default risk --- Distance-to-default --- Emerging Markets --- Finance and Financial Sector Development --- Financial Intermediation --- Private Sector Development --- Systemic risk --- Too big to fail

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This paper examines the association between the default risk of foreign bank subsidiaries and their parents during the global financial crisis, with the purpose of understanding what factors can help insulate affiliates from their parents. The paper finds evidence of a significant positive correlation between parent banks' and foreign subsidiaries' default risk. This correlation is lower for subsidiaries that have higher capital, retail deposit funding, and profitability ratios and that are more independently managed from their parents. Host country regulations also influence the extent to which shocks to the parents affect the subsidiaries' default risk. In particular, the correlation between the default risk of the subsidiary and the parent is lower for subsidiaries operating in countries that impose higher capital, reserve, provisioning, and disclosure requirements and tougher restrictions on bank activities.

Access to Finance --- Bank Subsidiaries --- Banking Crises --- Bankruptcy and Resolution of Financial Distress --- Banks and Banking Reform --- Corporate Law --- Debt Markets --- Default Risk --- Distance to Default --- Finance and Financial Sector Development --- Law and Development --- Merton Model --- Ring-Fencing

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Although financial theory suggests a positive relationship between default risk and equity returns, recent empirical papers find anomalously low returns for stocks with high probabilities of default. The authors show that returns to distressed stocks previously documented are really an amalgamation of anomalies associated with three stock characteristics - leverage, volatility and profitability. In this paper they use a market based measure - corporate credit spreads - to proxy for default risk. Unlike previously used measures that proxy for a firm's real-world probability of default, credit spreads proxy for a risk-adjusted (or a risk-neutral) probability of default and thereby explicitly account for the systematic component of distress risk. The authors show that credit spreads predict corporate defaults better than previously used measures, such as, bond ratings, accounting variables and structural model parameters. They do not find default risk to be significantly priced in the cross-section of equity returns. There is also no evidence of firms with high default risk delivering anomalously low returns.

Accounting --- Bankruptcy --- Bankruptcy and Resolution of Financial Distress --- Bond ratings --- Bond Spread --- Capital Asset Pricing --- Corporate Bond --- Corporate bonds --- Corporate defaults --- Credit rating --- Credit risk --- Credit spread --- Credit spreads --- Debt --- Debt Markets --- Default Risk --- Deposit Insurance --- Economic Theory & Research --- Equity returns --- Finance and Financial Sector Development --- Fixed Income --- Human capital --- International Bank --- Macroeconomics and Economic Growth --- Mutual Funds --- Probability of default --- Stocks

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Although financial theory suggests a positive relationship between default risk and equity returns, recent empirical papers find anomalously low returns for stocks with high probabilities of default. The authors show that returns to distressed stocks previously documented are really an amalgamation of anomalies associated with three stock characteristics - leverage, volatility and profitability. In this paper they use a market based measure - corporate credit spreads - to proxy for default risk. Unlike previously used measures that proxy for a firm's real-world probability of default, credit spreads proxy for a risk-adjusted (or a risk-neutral) probability of default and thereby explicitly account for the systematic component of distress risk. The authors show that credit spreads predict corporate defaults better than previously used measures, such as, bond ratings, accounting variables and structural model parameters. They do not find default risk to be significantly priced in the cross-section of equity returns. There is also no evidence of firms with high default risk delivering anomalously low returns.

Accounting --- Bankruptcy --- Bankruptcy and Resolution of Financial Distress --- Bond ratings --- Bond Spread --- Capital Asset Pricing --- Corporate Bond --- Corporate bonds --- Corporate defaults --- Credit rating --- Credit risk --- Credit spread --- Credit spreads --- Debt --- Debt Markets --- Default Risk --- Deposit Insurance --- Economic Theory & Research --- Equity returns --- Finance and Financial Sector Development --- Fixed Income --- Human capital --- International Bank --- Macroeconomics and Economic Growth --- Mutual Funds --- Probability of default --- Stocks