Stochastic Inter-Temporal Optimization in Discrete Time

Abstract

Data on the credit rating of bonds issued in the first half of the 1990s suggest that investors in emerging market securities paid little attention to credit risk, or that they were comfortable with the high level of credit risk that they were incurring¹. The compression of the interest rate yield spread prior to² and the subsequent turmoil in emerging markets have raised doubts about the ability of investors to appropriately assess and price risk. After the 1997 crises, Moody’s credit rating agency wrote that there was a need for a “paradigm shift” that involves greater analytic emphasis on the risks associated with the reliance on short-term debt for otherwise creditworthy borrowers.

This section relies on International Monetary Fund, International Capital Markets, Washington DC (1999), and International Monetary Fund, Anticipating Balance of Payments Crises, Occasional Paper #186, (1999).

The market expectations as embodied in interest rates did not widen significantly prior to the Mexican crisis. In the Asian crises, spreads hardly increased in the months prior to the floatation of the Bhat. The credit rating agencies and the market analysts all failed to signal the Asian crises in advance. They downgraded these countries only after the crises.