In Search of Distress Risk in Emerging Markets

Abstract

This working paper was written by Gonzalo Asis (University of North Carolina at Chapel Hill) and Anusha Chari (University of North Carolina at Chapel Hill & NBER).

Although the non-financial corporate sector accounts for the lion’s share of the post-Global Financial Crisis surge in emerging-market leverage, there is little systematic research on factors that impact corporate distress risk in emerging markets. Existing bankruptcy risk models developed using US data have low predictive power when applied to emerging market firms. We suggest that these models do not account for emerging market vulnerabilities to global shocks such as advanced economy monetary policy changes, US dollar movements, or shifts in global liquidity and risk-aversion. A novel multi-country dataset of corporate defaults allows us to quantify the importance of global shocks on emerging market corporate distress. Using a set of accounting, market, and macroeconomic variables, we develop a model of distress risk specific to emerging markets with comparable forecasting power to that of existing models based on US data. We also explore the asset pricing implications of our model by testing whether equity returns accurately reflect default risk. We find that global factors like US interest rates and credit risk contribute more predictive power for corporate default risk than domestic macroeconomic variables, especially for those firms whose stock returns are most sensitive to global financial conditions.

Keywords: emerging markets, corporate distress, bankruptcy risk models, global factors, asset prices

JEL Classification: F3, G15, G33