Interest Risk and Credit Risk Incidences on Capital Costs: Inter-temporal Modelling and Empirical evidence on the Swiss and International Stock Markets
Suisse, Etats-Unis, Royaume Uni
This study examines for three countries, that is the US, the UK and Switzerland, whether interest rate and credit risks are priced in the equity excess returns of their respective stock market indexes over the period January 1983 - respectively February 1993 and January 1988 - to April 1999, by estimating both two-factor and three-factor versions of Merton's ICAPM. The degree of dependence and causality between the domestic credit risk premia in order to assess the potential benefits of international diversification is also studied. Only weak evidence of systematic interest rate risk pricing is found, while under systematic credit risk can be concluded that market and credit risks are both positively and significantly priced. Finally the authors fail to observe strong relationships between the credit risk premia estimated on the three stock markets.
In this study we have examined for three countries, that is the US, the UK and Switzerland, whether interest rate and credit risks are priced in the equity excess returns of their respective stock market indexes over the period January 1983 - respectively February 1993 and January 1988 - to April 1999. Relying on bivariate and a trivariate Garch (1,1) in mean versions of Merton's ICAPM, we were able to reach the following conclusions. First , as far as the pricing of interest rate risk is concerned, the results obtained by Scruggs(1998) on the US stock market do not seem to extend to alternative interest rate state variables nor to other European countries in our sample. Accounting for interest rate risk does not necessarily restore a positive and significant unitary market price of risk nor does it necessarily lead to a significant and positive total interest rate risk premium. Second, the pricing of systematic credit risk is confirmed on all three markets but there is only weak evidence of the latter
unitary premium to be time -varying. Furthermore, once we account for systematic credit risk, a significant positive unitary market risk premium is observed in each country.The credit risk premium in all countries is non-negligible as it represents on average more than 50 % of the total market excess expected return.Third, the credit risk premia are only weakly correlated across the three markets and there is only weak evidence of any causality in their joint evolution. The estimation results for the trivariate Garch (1,1) in mean model led us to accept the hypothesis that both interest rate and credit risks significantly affect the equity returns on the Swiss market. But, when estimating a full trivariate Garch (1,1) in -mean model, the results did not converge for the UK due to the lack of data. The parameter estimates for the US also raised some doubts with respect to their economic relevance:This may be due to the leads and lags characterizing the dependencies between the state variables and the dependentvariable abnd the fact that these are not properly accounted for by the multivariate Garch (1,1) specification of their joint time series evolution. Furthermore, we also mentioned that the difference in significance of the interest rate as a state variable on the Swiss and on the US stock markets may be attributed to the different targets pursued by their monetary policies . Finally, the small sample size\ is clearly a limitation for the empirical results drawn from the current study and especially for its implication regarding the credit risk premia variation across the business cycles.
Examined in conjunction, these empirical results indicate that the pricing of systematic credit risk is quite robust across countries and across alternative specifications of the excess return generating process chosen to model excess equity returns. At this stage, there exist several possible extensions of the current study. First, it would be useful to extend this study to alternative credit risk proxy variables. Unfortunately, it is rather difficult to gather such data for all non-US markets. Second, it would be interesting to examine whether the systematic credit risk pricing extends to Emerging stock markets and whether it plays a significant role in explaining their equity premia. Third, looking at the pricing of systematic credit risk at the industry level could also provide us with some insights into the added benefits of cross-sectorial diversification especially during recession periods.
From a theoretical perspective, it would be useful to recast the analysis of the systematic credit risk premium within a partially segmented international ICAPM framework to obtain a better assessment of the role played by the European monetary unification, by heterogeneity in domestic credit risk policies and by market frictions on the diversification of credit risk at the international level.This would in turn allow us to assess the implications of the pricing of systematic credit risk for international equity portfolio management purposes.
Analyse économétrique. Estimation empirique d'un modèle théorique. Il s'agit de régresser non linéairement les indices boursiers nationaux sur des variables mesurant les risques de crédit et de taux d'intérêt. Méthode GARCH -General Autoregression Conditional Heterskedasticity- multivariée.
|Start - End date||01.10.1999 - 28.09.2001|