Campbell R. Harvey
Duke University and NBER
Andrew H. Roper
Duke University
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Emerging markets can provide substantial returns to foreign investors. However, emerging markets also introduce investors to new sources of economy/region wide risks not present in more developed markets.
•Latin Debt Crisis (1980)•Mexican Peso Crisis (1994)
•Asian Crisis (1997)
•Russian Ruble Crisis (1998)•Brazilian Real Crisis (1999)
Crisis, Emerging Markets, and Risk
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Crisis, Emerging Markets, and Risk
In order to understand the risk of investing in emerging markets, we must understand these crises.
•What were the causes (indicators) of the crisis?
•What were the remedies (resolutions) of the crisis?
Both involve risks!
We will focus on the first.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Crisis, Emerging Markets, and Risk
Crises are “worst case” scenarios for foreign investors.
•Increased political risk
•Increased currency risk
•Increased financial risk
Crises tend to follow periods of political change and the resolution of crisis usually involves dramatic changes from the status quo policy. Capital controls, government appropriation of private corporates, and government led corporate restructuring are common place during the resolution of crises.
Crises are often accompanied or triggered by dramatic changes in exchange rates. Government’s often impose capital controls and/or strict guidelines on foreign exchange rate transactions during crises.
Crises lead to liquidity shortages as domestic financial institutions face large amounts of non-performing loans and foreign lenders reconsider the risk/return relationships in the region.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
The Signs on the WallEarly “Indications” of the Crisis to
ComeHanbo Steel collapsed under large debt service obligations in Jan-97. The following month, Somprasong failed to meet its foreign debt obligations. “I don’t see any reason for the crisis to
develop further.” Managing Director of the IMF
(Jan-97)In May-97, the Thai government suspended operations of Finance One.
“We will never devalue the baht.”
Prime Minister of Thailand
(May-97) In June-97 Thailand suspended 16 cash strapped finance companies.
“We will never devalue the baht.”
Prime Minister of Thailand
(June-97)
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Learning from the Past
Prescribing the causes of the crisis ex-post can be detrimental and uninformative. In order to not be trapped into a sense of false sense of security, we should seek instead to uncover characteristics which helped to promulgate the crisis.First, we look at the usual suspects.
•Macroeconomic imbalances
•Foreign speculators
•Asset price bubble
•Micro (firm level) analysis
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Stock Market Return Performance
Setting the Record Straight
The return performance of East Asian stock markets varied across countries. However, during the 1990s the return performance throughout East Asia lagged behind the US market.
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Por
tfol
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( Ini
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Inv
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100
)
Taiwan
Indonesia
Korea
Malaysia
Philippines
Thailand
USA
Thai BahtDevaluation
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Jan-
95M
ar-9
5M
ay-9
5
Jul-9
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95N
ov-9
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Jan-
96M
ar-9
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ay-9
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Jul-9
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96N
ov-9
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Jan-
97M
ar-9
7M
ay-9
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Jul-9
7
Sep-
97N
ov-9
7
Jan-
98M
ar-9
8M
ay-9
8
Jul-9
8
Sep-
98
East Asia (Ex-Taiwan)
East Asia
-400
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200
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Net
US
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East Asia (Ex-Taiwan) East Asia
Foreign Equity InvestmentNet Purchases of Foreign Equity by US
Investors
Taiwan experiences $283 million capital outflow.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Micro Level Stylized Facts
As the 1990s progressed . . .
•Asian corporations experienced a decline in performance.
•Asian corporate managers borrowed substantially from international capital markets in foreign currencies (US Dollars).
•Asian corporate managers increased the leverage of their firms.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Trends in Corporate Profitability
Country Comparisons
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Median ROIC Across Countries
19921996
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Trends in Corporate Leverage RatiosCountry Comparisons
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ones
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Kor
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Median Leverage Across Countries
1992
1996
Rating Ratio
AAA 13.4
AA 21.9
A 32.7
BBB 43.4
BB 53.9
B 65.9
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Trends in Corporate Coverage RatiosCountry Comparisons
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12
3
4
56
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89
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Ind
ones
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Kor
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Phi
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Tai
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Tha
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Median EBITDA by Interest Payable
1992
1996
Rating Ratio
AAA 20.3
AA 14.94
A 8.51
BBB 6.03
BB 3.63
B 2.27
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Financial Risk of Foreign Debt
A firm’s leverage ratio encompasses all forms of debt, including foreign debt. When we think about the financial risk of debt, we need to consider both the maturity of the debt and the denomination of the debt.In general, Asian corporate borrowed short term and often times in dollar denominated issues.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Trends in External FinancingInternational Bond Offerings from East Asia
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
1990
1991
1992
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1996
1997
Dollar
Total
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
The Next Logical Step is Value at Risk
The substantial foreign exchange exposure of Asian corporation is difficult to quantify with standard methods. •For example, standard risk analysis would regress stock returns on the foreign exchange rate change. This statistical measure would suggest no significant exchange rate exposure.
However, a Value at Risk analysis could have uncovered potential weaknesses throughout the region prior to the crisis.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Value at Risk: The Next Logical Step
Harvey and Roper (1999) suggested this analysis. Their proposed exercise was simple.
Using detailed data on firm’s debt liabilities, we can stress test a firm’s coverage ratio under various interest rate and exchange rate scenarios.
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Value at Risk: Illiquid Firms
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Sensitivity Analysis of Coverage Ratio
Both FX Shock Interest Rate Shock
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
Value at Risk: Insolvent Firms
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Tha
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Sensitivity Analysis of Coverage Ratio
Both FX Shock Interest Rate Shock
"The Asian Bet" by Campbell R. Harvey and Andrew H. Roper
The Asian Bet
Asian corporate managers “bet” their firms when they increased leverage in the face of declining profitability. They raised the stakes by issuing foreign currency denominated debt.
We conclude . . .