A Pure Test for the Elasticity of Yield Spreads

minimal.

Tax effects may also explain the divergence in empirical results for credit spreads
where the risky bond is a Eurobond, or similar offshore security. For example, Wagner,
Hogan and Batten (2005) adopt the Longstaff and Schwartz (1995) two-factor regression,
extended for correlated spread changes and heteroskedasticity to investigate Deutschemark-
denominated Eurobonds. They find that while changes in spreads are significantly negatively
related to the term structure level, contrary to structural theory, the proxy for the asset value
does not yield a significant negative contribution, while for long bond maturities there is a
significant positive relation The authors interpret this result as being consistent with (i)
portfolio rebalancing or substitution effects (where long maturity high quality bonds are
traded for stocks), and (ii) a market risk premium on corporate bonds, which dominates
default risk. This later conclusion is consistent with Elton et al. (2001) where a time-varying
premium for bearing risk in capital markets may yield a systematic risk premium for
corporate bonds with the sensitivity of credit spreads to systematic risk factors tending to
increase for longer maturities and lower credit quality.

However, these authors do not consider the different tax treatment that applies to
domestically issued government bonds as opposed to Eurobonds from the international
investor viewpoint. In most countries Eurobonds are able to be issued by resident
corporations in such a way that they avoid with-holding tax provisions otherwise payable to
their international investors. These provisions normally allow for the exemption to the
payment of with-holding tax when the issue is “publicly available” and “widely distributed”.
The legal test for this varies for each country but normally relies upon whether the issue is
listed on an exchange and the face value of each specific bond. Low face values enable the
bond to be widely circulated and therefore “widely distributed”. These same exemptions are
not necessarily available to foreign investors who buy domestic corporate and government
bonds. Consequently the overall effect on credit spread pricing is not clear-cut since it would
depend on the extent that foreign investors were involved in the domestic government bond

<<   8   9   10   11   12   13   14   >>

More intriguing information