The politics of joint sovereign borrowing: The Venezuelan/Argentine Bono del Sur

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The politics of joint sovereignborrowing: The Venezuelan/Argentine Bono del SurLauren M. Phillips aa Department of International Relations , LondonSchool of Economics and Political Science , London ,UKPublished online: 31 May 2012.

To cite this article: Lauren M. Phillips (2013) The politics of joint sovereign borrowing:The Venezuelan/Argentine Bono del Sur, Review of International Political Economy, 20:3,576-604, DOI: 10.1080/09692290.2012.683035

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Review of International Political Economy, 2013Vol. 20, No. 3, 576–604, http://dx.doi.org/10.1080/09692290.2012.683035

The politics of joint sovereign borrowing:The Venezuelan/Argentine Bono del Sur

Lauren M. Phillips∗

Department of International Relations, London School of Economicsand Political Science, London, UK

ABSTRACT

This article investigates how credible commitment evolves when sovereignstates borrow jointly. In 2006, Venezuela and Argentina issued a package of‘joint’ sovereign bonds, which were later tradable separately. Despite the factthat Venezuela did not explicitly guarantee the Argentine component of thebond, this paper shows through a series of GARCH models that the finan-cial markets have traded the bond on the basis of news about Venezuela’spolitics, macro economy and its commitment to the bond and other regionalintegration projects. This is because the bond was embedded in a more ex-tensive set of financial and political relationships between the two countries,and served as a commitment mechanism, enhancing Argentine credibility.The article demonstrates that bilateral economic and political relationshipscan serve as a credible commitment device in the absence of changes todomestic institutions or longer-term re-establishment of reputation.

KEYWORDS

Credible commitment; joint sovereign borrowing; emerging market debt;Venezuela; Argentina; Bono del Sur.

∗Previous versions of this paper were presented at the Society for the Advance-ment of Socio-Economics’ 21st annual meeting, July 16–18, 2009 and at variousresearch workshops at the London School of Economics. The author would like tothank participants in those seminars, as well as Javier Diaz-Cassou, Mark Manger,Danny Quah, Ken Shadlen, David Stasavage, Andrew Walter and four anony-mous reviewers for comments. Research assistance by Rajeev Sibal is gratefullyacknowledged. All errors remain my own responsibility.

C© 2013 Taylor & Francis

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http://dx.doi.org/10.1080/09692290.2012.683035

PHILLIPS: THE POLITICS OF JOINT SOVEREIGN BORROWING

INTRODUCTION

Political scientists and political economists have made a major contri-bution to the study of sovereign debt and creditworthiness. While itwas economists who initially noted the intrinsically political nature ofsovereign debt, which is distinguished from its corporate counterpartby the extent to which governments maintain the willingness to makescarce domestic resources available to repay foreign creditors (Bulow andRogoff, 1989; Eaton, Gersovitz, and Stiglitz, 1986), political scientists addedto this literature by noting the impact that changing political institutionsand partisanship can have on sovereign creditworthiness, both histori-cally (North and Weingast, 1989; Stasavage, 2002, 2003; Toms, 2007) andin the modern period (Bernhard and Leblang, 2006c; Block and Vaaler,2004). Throughout this literature, it is the institutions and actors specificto individual nation-states that determine both the external perception ofcreditworthiness and the internal political calculus about the costs andbenefits of repayment versus default. It is therefore instructive to analyzeexamples of joint sovereign borrowing from the standpoint of politics, tounderstand how political willingness to finance debt repayment, or credi-ble commitment, changes in this context.

While to some extent joint sovereign borrowing remains in the realmof the hypothetical, the Venezuelan and Argentine governments jointlyissued a series of bonds in 2006 called the ‘Bono del Sur’ or Bond ofthe South. Rather than being a single unified bond whose proceeds wereshared amongst the two countries,1 the first Bono del Sur issuance was apackage of bonds comprising two dollar-denominated domestic Argentinebonds (‘Bodens’) and one dollar-denominated domestic Venezuelan bond(‘TICC’).2 The three bonds were sold together on the primary markets asa package, but were tradable separately after issuance on the secondarymarkets. Additionally, the Venezuelan government had no legal obligationto guarantee the Argentine bonds. The second and third tranche of theBono del Sur launched in the following year had similar structures.3

Surprisingly, given the lack of explicit Venezuelan guarantee for the Ar-gentine bonds and the fact that the bonds traded separately on secondarymarkets, this paper presents evidence that the markets have treated thebonds as something unique and possibly unprecedented. Both the aver-age spread (a measure of risk) and the volatility of the Argentine bondsincluded in the Bono del Sur have been driven by news about Venezuela’spolitics, economy and its commitment to the bond project and other, simi-lar, regional integration initiatives. This is in contrast to Argentine domesticbonds of similar maturity, size and currency denomination, which do notappear to be affected by such news. In essence, the market has treated theArgentine bonds within the Bono del Sur as carrying an implicit Venezue-lan guarantee.

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REVIEW OF INTERNATIONAL POLITICAL ECONOMY

This paper argues that this is the case because the strong political un-derpinnings of the Bono del Sur served as a commitment mechanism,allowing Argentina to enhance perceptions of its creditworthiness andprovide it much needed access to debt financing. It followed on a seriesof projects which created an increasingly close and important financialrelationship between the Venezuelan and Argentine governments. Addi-tionally, the leaders of both countries attempted to imbed it in regionalinstitutions, such as the South American customs union, Mercosur, andthe nascent (and as of yet unrealized) ‘Bank of the South’ project. It wasalso broadly reflective of Venezuelan desires to use extraordinary incomefrom the sale of oil to further South American integration and indepen-dence from Washington-based sources of finance. Thus market partici-pants tended to see it as an extension of Venezuelan aid to Argentina andthe region, and have in turn traded it according to the strength of theVenezuelan commitment to these projects, and the strength and stabilityof the Venezuelan political economy.

By situating this unusual case in the literature on the politics of sovereigndebt, I am able to show that joint sovereign borrowing is just one of manyways in which states can build credible commitment. While the tradi-tional literature on sovereign creditworthiness has focused on buildingcredible commitment through institutional design or over time throughearned reputation, there is also a literature which looks at the ways thatsovereigns can utilize multilateral or bilateral political relationships to‘purchase’ creditworthiness through their foreign relations. This includesthrough relationships with institutions such as the International Mone-tary Fund (IMF or Fund) and through relationships with allied states.The Venezuelan/Argentine joint borrowing project allowed Argentina toenhance perceptions of its creditworthiness by linking its willingness torepay debt to that of a more creditworthy ally. Thus, this example providesinsight into how bilateral economic and political relationships impact per-ceptions of creditworthiness, and more specifically suggests lessons forstates that might seek to borrow jointly in the future.

The paper proceeds as follows. In the second section, I review the liter-ature on sovereign debt and credible commitment, and the multiple waysstates seek to augment perceptions of creditworthiness. The third sectionapplies this literature to the Bono del Sur and discusses the political andeconomic rationale for the joint issue. The section concludes with sev-eral testable hypotheses. The fourth section presents an empirical analysisof the performance of the Bono del Sur to support the hypothesis thatmarket actors have traded the bond as if it carried an implicit guaranteefrom Venezuela. The fifth section concludes, and suggests that the researchpresented here may be of increasing relevance as European countries con-sider how to solve the institutional problems which lay at the heart ofthe ongoing sovereign debt crisis, and in particular, to inform speculation

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about whether greater integration of Eurozone bond markets (through thecreation of joint Eurozone bonds) could help address these problems.4

SOVEREIGN BORROWING AS A PROBLEMOF CREDIBLE COMMITMENT

A common theme in the large literature on sovereign debt has been thedesignation of sovereign borrowing and repayment as a problem of cred-ible commitment from borrowers to lenders. The earliest theoretical treat-ments by economists note two peculiarities of sovereign debt – first, thatit depends both on the capacity of governments to repay as well as theirpolitical will to do so, and second, that there is no enforcement mechanismfor defaulted sovereign debt in a context where bankruptcy and nega-tive net worth are meaningless and collateral is difficult to secure (Bulowand Rogoff, 1989; Eaton and Gersovitz, 1981; Eaton, Gersovitz and Stiglitz,1986). In this context, sovereign debtors need to demonstrate credible com-mitment in order to access credit on acceptable terms.

Political economists have argued that governments can respond to thechallenge of establishing credible commitment to sovereign debt throughtwo mechanisms: institutional design or reputation (for a useful summarysee Drazen, 2000: 131).5 Literature in the first vein has stressed how the cre-ation of new political institutions over long periods of history might havepositive consequences for the establishment of creditworthiness. Northand Weingast’s seminal article on the institutional changes that occurredin the wake of the Glorious Revolution in seventeenth century Englandargues that the delegation of greater authority to the Parliament ensuredthat the monarch was credibly committed to repaying outstanding loans(North and Weingast, 1989; see also Weingast, 1997). While some schol-ars have argued that this argument overlooks the role of partisanship inexplaining changes in the ability of the English crown to access credit(Stasavage, 2002), it is consistent with a broader literature on institutionalsolutions to time inconsistency and credible commitment (see particular-lay literature on the delegation of monetary policy to independent centralbanks, notably Keefer and Stasavage, 2003; Persson and Tabellini, 1993;Rogoff, 1985).

In contrast, reputational models focus on the ways that governmentscan prove over time that they are credible borrowers. Tomz for exampleimagines a framework in which lenders are always skeptical about thecreditworthiness of new borrowers, demanding a premium for the possi-bility that they will prove unreliable in repayment (Tomz, 2007). Over time,borrowers demonstrate themselves to be one of several ‘types’ of sovereignborrowers. While moving into less favorable categories happens immedi-ately after a credit event, Tomz demonstrates that it is much more difficultto be reassessed into a more favorable category. (Tomz, 2007: 104–8).

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While institutional and reputational models of credible commitmentfocus on changes made to domestic institutions, incentives and policies,the literature also suggests ways that countries attempt to solve the prob-lem of credible commitment by building external relationships. States can‘tie their hands’ and thereby enhance the creditworthiness of their com-mitment to repay sovereign debt by establishing and strengthening re-lationships with international institutions or other sovereign states. Twointernational institutions have been particularly important for helping toestablish debt creditworthiness: the IMF for developing countries, and inthe more limited case of Europe, the European Central Bank (ECB).

IMF lending programs have often been imagined, by the Fund itself andby academic observers, as a way in which countries can establish crediblecommitment through accepting the conditions of IMF loans (Dhonte, 1997;Edwards, 2006; Guitian, 1995). Facing a shortfall of funding from private,international sources, countries can borrow from the IMF in order to meettheir short-term financing needs and restore credibility, in turn catalyzingflows of private capital (Edwards, 2006; Mody and Saravia, 2003).6 TheIMF is thought to be able to play this role because in the context of theincomplete information game of sovereign debt, an IMF accord signalsthat the economic policy program adopted by the government is likely torestore growth and competitiveness (though for dissenting voices on thecapacity of IMF funding to catalyze private finance see Bird and Rowlands,2002; Rodrik, 1996).

A similar logic is at play with regards to the Eurozone: by meeting thecriteria for Eurozone entry, European states enhanced their commitmentto low inflation, with indirect effects on sovereign debt. Stanley Fischeris quoted as describing the European Monetary System as ‘an arrange-ment for France and Italy to purchase a commitment to low inflationby accepting German monetary policy’ (Fischer, 1987: 22–3, as quoted inFrenkel and Goldstein, 1996),7 an idea formalized by Giavazzi and Pagano(1988). In the case of the euro it is clear that the commitment to a com-mon monetary policy (and related fiscal rules) had a dramatic effect on theperceived creditworthiness of European debt: until the recent sovereigndebt crisis, spreads on European bonds narrowed, allowing Europeanstates which had traditionally been judged as less creditworthy to financetheir sovereign borrowing at rates nearly equal to those paid by Germany(Magnanelli and Wolswijk, 2007).

A final set of examples suggest that countries can also enhance theircommitment to repay debt by obtaining support from more creditwor-thy allied states, the model that most closely fits the support Venezuelaprovided to Argentina through the Bono del Sur. Several states have uti-lized third-party guarantees on their debt to access more favorable termsof credit; the most prominent example of which is Israel, which, as partof a much broader strategic and aid relationship, has issued billions of

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dollars of sovereign bonds which carry the explicit guarantee of the UnitedStates (US) Treasury (Mark, 2005; Quigley, 1992). A larger but less bindingexample is the support that was provided by the US Treasury in the formof a bond exchange program known as the Brady Plan, a comprehensivesolution to the decade long Latin American debt crisis that included mak-ing long-term collateral in the form of US Treasuries available to underpinthe value of new, discounted debt instruments. Though this support, theUS facilitated the return of developing countries in Latin America andelsewhere to the international bond markets during the early 1990s (Cline,1995).

More recently, the European Commission, on behalf of the EuropeanUnion (EU), has issued jointly guaranteed debt to support: (a) countriesoutside of the EU in conjunction with ongoing IMF programs throughthe Macro-Financial Assistance program (since 1990, primarily to Cen-tral European EU candidate countries); (b) non-Eurozone European Mem-ber States in conjunction with the IMF through the Balance of Paymentsprogram (e.g., recently for Romania); and (c) countries receiving supportfrom the European Financial Stability Mechanism in conjunction with theIMF, notably Ireland and Portugal in January and June 2011. These bondsare jointly guaranteed by triple-A rated EU members, but funds madeavailable through the bond program are not shared amongst multiplestates.8

In summary, countries facing a problem in demonstrating credible com-mitment will seek to find ways to assure investors that they will maintaincontractual obligations to repay. This may include enhancing their repu-tation by linking their creditworthiness to that of an allied state. The nextsection assesses to what extent the Bono del Sur represented this type ofexternal assurance of credibility.

THE BONO DEL SUR AND CREDIBLE COMMITMENT

As was briefly outlined in the introduction, the Bono del Sur was not asmuch a ‘joint’ sovereign bond as it was a package of bonds from twoindependent sovereign states sold together. The Venezuelan bonds andArgentine bonds provided separate revenue streams to each state, andthough Venezuelan investors who bought the Bono del Sur at the time ofissuance were required to buy a package of mixed national bonds, theycould sell off the three bonds individually on the secondary markets. Afterissuance, the Venezuelan government had no legal obligation to guaranteethe Argentine bonds.

And yet the evidence presented in the empirical section of this papersuggests that international investors who bought and sold the Argentinebond included in the Bono del Sur on the secondary markets considered

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news about Venezuelan politics, macroeconomics and the country’s com-mitment to Argentina salient in determining its risk rate. Put differently,the Bono del Sur changed investor perceptions of which variables wereimportant to judge Argentina’s commitment to repaying its debt. In thissection, I explain why this might have been the case, focusing on the under-lying political and financial relationship between Venezuela and Argentinawhich pre-dated the Bono del Sur, and then articulate a set of theoreticallyderived and empirically testable hypotheses.

Venezuela’s commitment to Argentina, and the region

Since his election in 1998, Venezuelan President Hugo Chavez has madeSouth American integration a major element of his political platform, withfrequent references to Simon Bolıvar’s vision of a united South Americaor ‘Gran Colombia.’ A complimentary goal has been the articulation of a‘Bolivarian socialist’ alternative to US-led globalization in Venezuela andelsewhere in Latin America (Sylvia and Danopoulos, 2003). Central is theuse of state resources, principally oil revenue, to pay for enhanced socialprograms in Venezuela and abroad.

As part of these ongoing objectives, and in the context of extraordinarilyhigh international oil prices in the mid-2000s, Venezuela embarked on anambitious foreign aid program, providing concessionary loans and aid inkind to neighboring Latin American governments. In 2007, Venezuela wasproviding 200,000 barrels of oil a day with an estimated value of US$1.6billion a year through arrangements with 17 Latin America and Caribbeangovernments.9 The structure of these deals varied, but a common com-ponent was that the oil-importing state would finance the oil purchasesthrough low-cost, long-term borrowing from Venezuela. Repayments weremade partially in cash and partially in exports of goods (or services in thecase of Cuba, see Shifter, 2006: 52).10 Foreign aid also contained non-oilcomponents, including pledges for construction of infrastructure and so-cial projects in Latin America. In 2005, the estimated value of these pledgeswas $5.5 billion,11 including donations, loans and the purchase of bonds,about which more is said below.

While Venezuela has made cheap oil available to low income neigh-bors and allies, it utilized market-oriented strategies to support wealth-ier neighbors like Argentina. By 2006, Venezuela had purchased US$3.5billion of Argentine bonds in an effort to provide foreign assistance(Alvarez and Hanson 2009). Some of those bonds were purchased in 2004so that Argentina could repay its obligations to the IMF early. This allowedVenezuela to achieve two things with the same policy: reduce the perceiveddominance of Washington in the region, and augment the Venezuelan/Argentine relationship as a stepping-stone to greater South American in-tegration. Venezuela also purchased US$25 million of the first Ecuadorian

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bonds issued since its 1999 default in 2004 (a symbolic gesture as this rep-resented only 4 per cent of the debt issue). Suggestions were also made in2007, after the electoral victory of former Sandinista leader Daniel Ortegain Nicaragua, that Venezuela might also purchase some of its large foreigndebt.12

Additionally, Venezuela pursued several mechanisms to institutional-ize their growing financial and political relationship with Argentina priorto the announcement of the Bono del Sur. First, it sought to become afull member of the South American customs union, Mercosur, in 2006,joining Argentina, Brazil, Uruguay and Paraguay along with several otherassociate members. Secondly, Chavez set the stage for the creation of aSouth American development Bank, the ‘Banco del Sur’ (or Bank of theSouth) that would make loans to South American governments for projectsthat promoted regional integration. The Bank was envisioned as an alter-native source of development financing, decreasing Latin American de-pendence on Washington-based international financial institutions. Bothdemonstrated Chavez’s willingness to institutionalize the relationship be-tween Venezuela and South American neighbors.

The Bono del Sur is linked to both of these efforts to institutionalize theVenezuelan/Argentine relationship. The idea of the Bono del Sur was firstannounced by Chavez and the late Argentine president Nestor Kirchneron 6 July 2006, the day that Venezuela was to become a full member ofMercosur. During that announcement, the two leaders also linked the ideaof a joint sovereign bond to raising capital for the Banco del Sur. Kirchnerannounced that the bond would be a precursor for ‘the construction of abank, a financial space in the south that will permit us to generate lines offinance which answer our regions’ [sic] and societies’ needs’. Similarly, theVenezuelan finance minister suggested that it would have major implica-tions for understanding of sovereign risk, evolving towards a concept of‘regional risk’.13

Given this context, the Bono del Sur appears to have enjoyed excep-tionally strong political support from the Venezuelan government. It washighly consistent with Venezuelan foreign policy under Chavez and thejoint bond has been explicitly tied to new institutional relationships be-tween the two governments. A desire to formalize Venezuelan purchasesof Argentine debt into a new instrument is further indication of this polit-ical commitment.

Skeptics might point out that Venezuela derived a substantial materialbenefit from the joint issue: the bond enhanced domestic access to scarceUS dollars, mopping up liquidity and helping to combat inflation. Butthis positive financial externality for Venezuela could have been equallywell achieved through the issuance of a Venezuelan domestic bond (as hasbeen done subsequently with the ‘El Venezolano’ issues) and, as such, liq-uidity appears to play a relatively weak role in explaining the Venezuelan

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government’s interest in the Bono del Sur. Purchasers of the bond, whichwere limited to Venezuelans at issuance, also benefited from the substan-tial difference between the official Venezuelan exchange rate and the blackmarket rate.

But demand for the bond since issuance cannot be explained by theprofit or liquidity motive: the Argentine component of the Bono del Suris now held to a significant degree by large international investors in theUnited States and Europe, who have purchased the bond on the secondarybond markets.14 International investors have bought the bonds included inthe Bono del Sur in order to build portfolio exposure to Argentina, whosepost-default growth has been impressive.15

Argentina’s motivation for the Bono del Sur

From the standpoint of Buenos Aires, the borrowing relationship betweenArgentina and Venezuela in the mid-2000s was a result of the debt defaultand financial crisis that began in December 2001 and the political reconfig-uration and economic conditions that emerged after the crisis. Unlike theforeign policy incentives for Venezuela, Argentina’s interest in the jointissue was expedient from the standpoint of post-crisis domestic politics,and necessary from an economic and legal perspective.

Argentina’s more than $150 billion foreign debt default in December2001 was the largest sovereign default in history. Much has been writ-ten about the complexities of organizing a restructuring of this debt: thenumber of bonds and the diversity of the holders and legal jurisdictionsmade coordinating negotiating positions for a settlement particularly dif-ficult (Dhillion et al., 2005; Miller and Thomas, 2006). Even after Argentinaachieved one of the most favorable deals with its bondholders in mod-ern sovereign borrowing history (forcing investors to take a 70 per centwrite down in the net present value of their bonds), Argentina contin-ued to face problems in accessing the capital markets because of unsettledobligations with the remaining 24 per cent of creditors who failed to ac-cept the brokered deal. The pursuit of financing independent of the IMFor international creditors therefore became an important (and financiallyand legally necessary) goal for the government. Venezuela’s willingness tobuy Argentine debt complimented domestic political strategy under theadministration of President Kirchner, which included ‘launching high pro-file battles against . . . the military, the IMF, bondholders and foreign anddomestic capitalists’ (Levitsky and Murillo, 2008: 22). Furthermore, thepending elections of 2007 provided an additional incentive to formalizethe cooperation with Venezuela. Continued access to Venezuelan capitalthrough the Bono del Sur allowed the Kirchner administration to avoidbreaking a political taboo by returning to the IMF.16

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By issuing debt in the Venezuelan markets through the Bono del Sur, theArgentine government solved two vexing problems that remained afterthe 2001 debt default. First, how to raise new debt when any bonds issuedin international financial centers like New York or London were liable tobe seized by remaining ‘hold-out’ creditors in courts in those jurisdictions.Second, and more importantly, the Bono del Sur solved a more fundamen-tal problem: how to enhance perception of credible commitment in thewake of their recent default.

As discussed in the literature review, states seeking to enhance credi-ble commitment can adapt domestic institutions, build reputation or seekexternal solutions. The anti-market, nationalistic ideology of the Kirchneradministration made making changes to domestic institutions to enhanceexternal credibility unlikely; the technical problems of issuing new debtmade establishing credible commitment through slow gains to reputa-tion impossible. The obvious external guarantor of Argentine credibilitywas Venezuela, whose previous bond purchases had already established aprecedent. This was especially true because the Kirchner government washighly confrontational towards more traditional sources of external guar-antee like the US government and the IMF. Thus, the extensive politicaland financial relationship with Venezuela that underpinned the Bono delSur provided a good way to externalize the credible commitment problem,having precisely the impact the Venezuelan finance minister hypothesizedit might (building towards a concept of regional, rather than individual,sovereign, risk).

If the above argument is correct, and the implicit guarantee createdby the political relationship with Venezuela helped Argentine to generatecredible commitment, there should be a material benefit for Argentina interms of risk and financial market volatility. The broadest possible im-pact would be that Argentine risk measured at the macro-level (so-calledcountry risk) would decline. This is relatively unlikely given the limitednature of the Venezuelan guarantee described. A more moderate impact,and one more in keeping with the implicit guarantee, would be changes tothe average risk rate (measured as the spread over a risk-free US Treasury)and volatility of the particular Argentine bonds included in the ‘joint’ is-sue. Whereas bonds usually trade on the basis of domestic macroeconomicand political conditions, this bond may instead trade on the basis of newsabout Venezuelan politics and economics, as the willingness and capacityof Venezuela to continue financing Argentina becomes key to the bond’screditworthiness.

Additionally, a bond with an implicit external guarantee may respondto news about the guarantors changing willingness to continue support-ing the allied state. In this case then, the Argentine bonds forming part ofthe Bono del Sur may be affected by news about Venezuelan politics, eco-nomics or its commitment to Argentina and the broader political project

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of regional integration. I test to see what impact the relationship withVenezuela had on investor’s perceptions of Argentine credible commit-ment in the fourth section of this article.

PERFORMANCE OF THE BONO DEL SUR

Prior to applying econometric techniques to discover what determinedthe average spread and volatility of the Argentine component of the Bonodel Sur, I first provide some descriptive statistics to determine the broaderimpact of the Venezuelan/Argentine financial relationship on perceptionof Argentine credible commitment.

Rather surprisingly given the conservative nature of the Venezuelanguarantee, in the period immediately following the launch of the bond(26 October 2006 to 31 December 2006), there was a significant decline inArgentine risk, bringing it much more closely aligned to Venezuelan riskpremiums. The difference in the average risk between the two countries inthis period declined substantially to just 55bp, or 0.5 per cent. The conver-gence of the risk rates, as measured by JPMorgan’s Emerging Market BondIndex (EMBI) for these two countries over the course of 2006 are shown inFigure 1. While this does not prove causation (i.e., that the Bono del Surhelped to reduce Argentine risk rates), it is a notable trend.17

JPMorgan EMBI Sovereign Risk Ratings, in basis points

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Figure 1 Argentine and Venezuelan sovereign risk, 2006.

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Another way to measure the impact of the Bono del Sur on perceptions ofArgentine and Venezuelan risk is to measure whether the co-movement ofthe spreads of their sovereign bonds increased. The performance of emerg-ing market bonds, and Latin American bonds in particular, are stronglycorrelated because credit conditions for these countries are highly sensi-tive to changes in international conditions and sentiment. Thus spreads foremerging market sovereign bonds tend to move in tandem: Mauro et al.find that the co-movement of emerging market bond spreads has a cor-relation coefficient of 0.71 for the period between 1994 and 2001 (Mauro,Sussman and Yafeh, 2006: 109–10).

It is therefore unsurprising that the correlation coefficients between Ar-gentine and Venezuelan sovereign risk in general are high: in 2006, priorto the issuance of the Bono del Sur, the correlation coefficient was 0.78, justhigher than that reported by Mauro et al for the EMBI countries as a whole.But after the issuance of the Bono del Sur, and before the acceleration ofthe international financial crisis (i.e., between October 2006 and September2008), the correlation coefficient increases significantly, to 0.95, far exceed-ing the EMBI average. This high degree of correlation suggests that metricsof Venezuelan and Argentine risk are responding to similar news after theBono del Sur and before the major financial turmoil of September 2008.

While the above descriptive statistics give a sense that the Bono del Suraffected perceptions of Argentine creditworthiness and credible commit-ment, econometric tests to determine the trading behavior of the bondsprovide a better sense of whether investors believed that economic con-ditions and political actions by Venezuela were predictive of Argentinecreditworthiness, and therefore bond spreads. I utilize a series of General-ized Auto-Regressive Conditional Heteroskedasticity (GARCH) models tocapture the impact of news about economics, politics and the Venezuelan/Argentine relationship on both the spread of Argentine bonds and thevolatility of those bonds. I also control for some market indicators, suchas an index of the performance of emerging market bonds, the crude oilprice and a variety of indicators on trading conditions in the United States.The remainder of this section describes these variables and tests in greaterdetail.

Dependent variables

Several Argentine bonds were included in the three tranches of the Bonodel Sur, but the Boden 2015, an Argentine domestic bond denominated inUS dollars which was first issued in 2005 (and thus pre-dated the Bono delSur), was part of all three tranches. I use daily pricing of the Boden 2015 asmy primary dependent variable to investigate the impact of the Venezuelanrelationship on the spread and volatility of the Argentine component ofthe Bono del Sur. As the time series exhibits a lack of stationarity (as

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demonstrated by diagnostic tests including an Augmented Dickey-Fullerand Phillips-Peron test), I transform it to the daily change in pricing.18 Thedataset runs from 26 October 2006, the date of the Bono del Sur’s issuance,to March 2009.

Later regressions, which are designed to act as further tests of the ro-bustness of my findings, use additional Argentine bonds as dependentvariables. The Boden 2013 and 2017, also Argentine domestic bonds de-nominated in US dollars, were never included in the Bono del Sur, and thusvariables related to Venezuela and the Venezuelan/Argentine relationshipshould not have an impact on the spread or the bonds volatility. As thematurity of bonds affects pricing, I control for the fact that neither has thesame maturity date of the Boden 2015 by testing both a bond that expirestwo years earlier and one that expires two years later. These variablesare also transformed into daily pricing changes in the manner describedabove.

I do not test the impact of the implicit Bono del Sur guarantee on theaverage spread or volatility of Venezuelan debt included in the bond pack-age. This is first because my core interest is to determine whether the Bonodel Sur helped the Argentine government to enhance credible commit-ment, not whether this provision of an implicit guarantee had financialconsequences for Venezuela. Additionally, there is limited secondary mar-ket trading data available on sources like Bloomberg for the VenezuelanTICC bonds included in the Bono del Sur.

Independent variables

The regressions include two types of independent variables: financial mar-ket controls which, similar to the dependent variables, are time seriescomprising daily data, and news dummy variables which provide infor-mation about changing economic and political conditions in Venezuela andArgentina to test for the impact of the countries’ unusual political relation-ship on bond performance.

I test for the significance of a number of financial market controls, allof which are expressed as daily changes. The first is the price of oil, andin particular, the daily change in the price of sour crude as Venezuelais a major exporter of this type of oil. This variable is likely to be ofsignificance as Venezuelan foreign assistance and commitment to regionalsupport and integration was highly dependent upon the price of oil. Intimes of falling oil prices, it would be logical for market participants toassume that Venezuela’s commitment to projects like the Bono del Surwould weaken. The second control is a broad measure of emerging marketrisk, captured by JPMorgan’s EMBI. This is a blended risk rate (spread)for all of the emerging market countries JPMorgan holds in its emergingmarket portfolio. Given the extent to which emerging market bonds trade

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together (noted in the descriptive statistics at the start of this section),this variable should be highly significant in explaining the spread of theArgentine bonds.

I add four further variables which attempt to capture the ways that thespread of emerging market bonds may vary given macroeconomic andfinancial conditions in markets such as the United States. I test the changeto the yield of a 5- and 10-year US Treasury Bill, used selectively dependingon the maturity structure of the bond used as a dependent variable. Asan alternative, I also tested the daily change to the US Federal funds rateand the difference in the price of the US 10-year T-bill and the three-monthTreasury. Neither the Federal funds rate nor the difference between US longand short tenure bonds was a significant predictor of the mean spread ofArgentine bonds in any of the specifications.19

Additionally, I coded pieces of news about Argentina and Venezuelafrom October 2006 to March 2009 from the Financial Times (FT) and usethese variables to test the perceived importance of Venezuelan support tothe Bono del Sur. These variables take the value 1 when there is news and0 when there is no news on the previous trading day.20 I chose the FT asa news source for several reasons. First because it is a primary source ofnews for international bond managers, along with two other daily papers,the Wall Street Journal (WSJ) and the New York Times. Given that the WSJwas, during the period under study, engaged in a public battle in theireditorial pages with the Venezuelan government,21 the FT seems a moreappropriate (i.e., unbiased) news source. Second, the FT is a good sourceof macroeconomic and oil market data, and thus bond managers with aninterest in the Bono del Sur would be even more likely to use the FT asa news source. Finally, using the FT as a news source is consistent withprevious work on the impact of financial news on market performance(see Baker, Nofsinger and Weaver, 2002; Mauro, Sussman and Yafeh, 2006;Veldkamp, 2006).22

Seventy-four articles are coded for Venezuela; 72 for Argentina (seeTable 1). These articles are coded if they fall into one of the following fivecategories:23

Table 1 News results, Venezuela and Argentina; Financial Times,26 October 2006–12 March 2009

Venezuela Argentina

Domestic politics 34 46Economics 18 26Commitment to region 22 NATotal 74 72

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• (1) ‘Ven Econ’ and (2) ‘Arg Econ’: News about releases of new economicdata such as GDP growth, trade and fiscal balances, inflation and othermacroeconomic indicators. Articles which present economic analysis arenot coded. Separate variables are generated for Venezuelan macroeco-nomic news and Argentine macroeconomic news.

• (3) ‘Ven Pol’ and (4) ‘Arg Pol’: News about domestic politics includ-ing stories about legislative politics, national or sub-national elections,candidacies, new policies or actions of the president or legislature, ju-dicial politics or changes to other government figures (e.g., ministers orsub-national political leaders). Articles which present longer-term polit-ical analysis are not coded. Similar to the above, separate variables aregenerated for Venezuelan politics and Argentine politics.

• (5) ‘Ven Commit’: News about Venezuela’s commitment to Argentinaand the region. Includes news about the Bono del Sur, regional integra-tion initiatives, political support for friendly regional governments andcandidates as well as news about foreign aid packages. News can bepositive (evidence of greater support for regional integration) or nega-tive (declining appetite for regional support). News about more generalVenezuelan foreign policy (e.g., border tension with Colombia, relationswith the United States) is not included. A full list of articles included inthis category is provided in Appendix 1.

The literature suggests that under normal borrowing conditions, newsabout Argentine domestic politics and economic should be the primarydrivers of the spread and volatility of Argentine bonds. However, in thecase of bonds linked to the Bono del Sur, it is possible that news of thissort will cease to be relevant to pricing, and instead, news about eitherVenezuelan domestic politics and economics or news about the govern-ment’s commitment to regional integration will instead take prevalence.Thus, news about Argentine economics and politics should have an impacton pricing of the Boden 13 and 17, while news about regional commitmentand/or Venezuelan politics and economics should have an impact on theBoden 2015 if the markets believe that the bond’s credibility depends oncontinued Venezuela support.

I do not directly test the impact of macroeconomic indicators (such asdebt to GDP ratios) or political institutions because these variables changeinfrequently, and are thus inappropriate in an estimation of daily financialmarket performance. My news variables instead act as proxies for thesevariables.

The model

I use a series of GARCH models to estimate the impact of the independentvariables described above on mean bond spread as well as bond market

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Table 2 Summary statistics of dependent variables

Daily change Daily change Daily changeBoden 2015 Boden 2013 Boden 2017

N 593 593 477Mean 0.39 0.48 0.35Stand Dev 3.55 7.88 4.64Skewness 0.82 0.21 0.89Kurtosis 8.50 7.53 21.9

volatility. This follows previous studies that have sought to determinethe impact of democratic political events on daily currency and stockmarket behavior (Bernhard and Leblang, 2006a, b; Leblang and Mukherjee,2004). Leblang and Mukherjee show that the GARCH family of models areamong the most appropriate for political scientists interested in mappingthe effects of political events on market volatility (Leblang and Mukherjee,2004: 297).

A series of diagnostic tests show that the data demonstratesautocorrelation,24 skewness and kurtosis (see Table 2 for summarystatistics),25 making the GARCH model, with robust standard errors, anappropriate estimation technique.26

The GARCH model estimates the mean behavior of a time series sepa-rately from the volatility. The mathematical expression of the mean equa-tion is:

St = η + Xtβ + εt

εt ∼ N(o, σ 2

t

)

where St is the daily percent change in the spread of the bond, η is constant,Xt is a vector of exogenous control variables expected to have an impact onthe performance of the bond and εt is a normally distributed error term.

The variance term is expressed by an ARCH term, ε2t−1, understood to

represent volatility shocks from previous periods plus a GARCH termσ 2

t−1, which captures the variance from the previous period. Additionally,I include a set of exogenous news variables thought to impact the varianceexpressed as xt and a constant. This can be expressed mathematically as:

σ 2t = ω + αε2

t−1 + βσ 2t−1 + πxt

where one ARCH term and one GARCH term are necessary to accuratelyrepresent the conditional variance: i.e., a GARCH (1,1) model.

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As is evident from the equations above, the model can account for theimpact of independent variables either in the mean equation, the volatilityequation or in both. The majority of previous studies which seek to un-derstand the impact of political variables on financial market performancehave argued that political variables should affect volatility rather than themean; the few that have included political variables in the mean equa-tion have not routinely found significance.27 As I am interested in seeingwhether variables about Venezuelan politics, economics and commitmentto regional integration affect average risk (as measured by the spread overa ‘risk-free’ US treasury) and/or volatility, I test the impact of my fivecategories of news variables in both the mean and volatility equationswhenever possible. In contrast, the financial market control variables areincluded only in the mean equation, as I expect that market conditions willhave an impact primarily on the average spread of Argentine bonds.

There are at least three possible adaptations to the standard GARCHmodel which may better capture the specificities of this data. The firsttwo adaptations, the exponential GARCH (EGARCH, see Nelson, 1991)model and threshold ARCH model (TARCH see Rabemananjara andZakoian, 1993; Zakoian, 1994) attempt to correct for the fact that the marketmay behave differently when volatility shocks are negative (the EGARCHmodel) or that there may be proportionally higher volatility when trad-ing volumes are heavy (the TARCH model). The third transformationasks whether volatility shocks exhibit long-memory, decaying slowly overtime, and tests to see whether the financial series being modeled is frac-tionally integrated (a fractionally integrated GARCH model or FIGARCH,see Baillie, Bollerslev and Mikkelsen, 1996, an adaptation of the IntegratedGARCH, or IGARCH, model given by Engle and Bollerslev, 1986). TheFIGARCH model can also be combined with the exponential model toform a FIEGARCH model (Bollerslev and Mikkelsen, 1996).

I test to see whether the data is fractionally integrated before testingwhether asymmetric shocks to volatility are best captured by the EGARCHand TARCH models. Tests which seek to determine whether the time seriesis stationary (the fractional integration term notated d = 0) or representa unit root (d = 1) present mixed results. Two of three widely used testssuggest that the time series representing the daily change to the spreadof the Argentine Boden 2015 is not fractionally integrated (see Table 3).Similar results are obtained for the Argentine Boden 2017 and 2013 (seeTable 3). Given the weak evidence of fractional integration, I do not testthe FIGARCH/FIEGARCH models, despite the fact that it has been usedin previous literature (Bernhard and Leblang, 2006a).

I do, however, test the EGARCH model, which assumes that negativevolatility shocks have a longer lasting and deeper impact on the structureof the time series. The volatility equation for the model is given as the

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Table 3 Fractional integration tests

DBoden 2015 DBoden 2013 DBoden 2017

Geweke/Porter-Hudak (GPH) estimatort-test (H0: d = 0) 0.9813 0.8177 1.5323z-test (H0: d = 0) 0.8499 0.6450 1.2463

Phillips modified GPH estimatort-test (H0: d = 0) 0.9288 0.8924 2.4230∗

z-test (H0: d = 1) −6.6460∗∗ −6.7729∗∗ −4.6636∗∗

Robinson estimatort-test (H0: d = 0) 2.6187∗∗ 0.3858 Not calculated

Notes: Fail to reject the null hypothesis of no unit root (d = 1) or stationarity (d = 0) with 99%confidence∗∗; 95% confidence∗.

below:

ln(σ 2

t

) = ω + α

(εt−1

σt−1

)+ γ

[∣∣∣∣ εt−1

σt−1

∣∣∣∣ − E∣∣∣∣ εt−1

σt−1

∣∣∣∣]

+ β ln(σ 2

t−1

) + πxt

where E is an expectations operator. The equation includes a constant, theGARCH term, and a symmetric and asymmetric ARCH term, as well asthe exogenous political and economic news variables. The TARCH model,which is less widely used in the literature on the volatility impact ofpolitics on financial markets, might be well suited to my news variableswhich could have a sudden effect on volatility. It not only captures thediverse impact of positive and negative shocks, it accounts for the fact thatsudden shocks may have a larger impact on volatility over time. However,as results presented in the next section demonstrate, the TARCH modelappears to be a poor fit to the data, perhaps because the independentnews variables do not represent sudden shocks, but rather help marketparticipants to update expectations more gradually.

Results

My results for the Boden 2015 (Argentine component of the Bono delSur) are presented in Table 4. Both the EGARCH and TARCH modelsconfirm the hypothesis that the markets traded this bond as if it carriedan implicit Venezuelan guarantee, with volatility strongly determined bynews about Venezuelan commitment to Argentina and the region, andnews about Venezuelan macroeconomic outcomes and political variablesaffecting both the mean and variance equation. While the EGARCH modelspecification is robust (as shown by tests on the residuals recorded at the

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Table 4 Bono del Sur regression resultsDependent Variable: Daily Change in spread of Boden 2015 (Argentine Compo-nent, Bono del Sur) 26 October 2006–12 March 2009EGARCH Model (Gaussian Distribution, Log Likelihood Estimation) with RobustStandard Errors TARCH Model (Gaussian Distribution, Log Likelihood Estima-tion) with Robust Standard Errors

I. EGARCH Model II. TARCH Model

Standard StandardCoefficient error Coefficient error

Mean EquationJPMorgan EMBI .6887∗∗∗ .0176 .6979∗∗∗ .0757US T-Bill10 .0438 .0436 .0897 .1015Sour Crude −.0718 .0450 −.1118∗∗ .0513Arg. Econ −.3027 .4914 −.1984 .5590Arg. DomPol −.5271 .4828 −1.090∗∗ .4866Ven. Econ .1971 .4024 .4881 .4043Ven. DomPol .6719∗∗∗ .0159 .2798 .2891Ven. Commit .4684 .3281 .1677 .3658Constanti — — .2767∗∗ .1258

Var EquationArg. Econ .0043 .2261 .1570 .3127Arg. DomPol .0529 .1139 .4952 .4456Ven. Econ −.3657∗ .2152 −1.005∗∗ .4126Ven. DomPol .0829 .1715 −.7483∗ .4260Ven. Commit −.6025∗∗∗ .1740 −.7907∗∗ .3121Constant .0829∗∗∗ .0317 1.854∗∗∗ .1617

ARCH/GARCHSymm. ARCH .0776 .0599 — —Asym. ARCH .1496∗∗∗ .0374 — —GARCH .9692∗∗∗ .0138 — —TARCH — — .3972∗∗ .1933

Residual tests Test statistic p-value Test statistic p-value

Q (12) 50.7392 0.1189 78.0839 0.0003Q2(12) 12.7503 1.0000 147.3321 0.0000

Significant at 1% level∗∗∗; Significant at 5%∗∗; Significant at 10%∗. iThe constant is droppedbecause there is co-linearity between the constant and the US Treasury Bill variable.

bottom of the table), the TARCH model suffers from potential misspecifi-cation. Therefore only results from the EGARCH model are discussed inmore detail.

The mean equation shows that changes to the spread of the Boden 2015is strongly affected by changes to the spread of emerging market risk moregenerally, as measured by the JPMorgan EMBI index. Changes to the priceof sour crude are not significant in the EGARCH estimation (though theyare in the TARCH estimation). With regards to my news variables, the

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mean EGARCH equation suggests that news about Venezuelan domesticpolitics has a strong impact on the average spread of the Argentien Bonodel Sur. This is a very striking finding, as news about Argentine domesticeconomics and politics are not significant. This suggests that the marketsees the credibility of this bond as inextricably tied to Venezuelan politics.

The variance equation also presents interesting results: the variablewith the largest impact on the volatility of the Boden 2015 is news aboutVenezuela’s commitment to Argentina and the Latin American region.News about Venezuelan economics is also significant, while news aboutthe Argentine domestic political economy does not. Taken together, thesetwo equations provide strong evidence that the financial markets havepriced and traded the Boden 2015 as having a deterministic relationshipto the overall performance of the Venezuelan political economy and to itsability and willingness to continue pursuing regional integration throughprojects like the Bono del Sur. Since the bond was not technically jointafter issuance, and Venezuela had no legal responsibility to guarantee thebond, the effect of this news on the price of the Boden 2015 is particularlyinteresting.

While the findings presented in Table 4 already present a striking pictureof the benefit to credible commitment the relationship with Venezuelaplayed in the risk and volatility of the Bono del Sur, the findings arefurther strengthened by the empirics in Table 5, which provide results forestimations of the two domestic Argentine bonds which were not includedin the Bono del Sur, the Boden 2013 and 2017. Testing these two bondsallows me to ensure that the findings above were not spurious; that isto say that variables about Venezuelan macroeconomic performance andcommitment to the region would impact any Argentine bond, perhaps asa proxy of confidence in the Latin American region more broadly. Similarto the regressions for the Boden 2015, while the EGARCH regressionsare robust, residual tests for the TARCH model suggest that the model ismis-specified. I therefore concentrate comments on the EGARCH model.

The EGARCH models shows that variables related to Venezuelanmacroeconomics, politics or commitment to the region do not have animpact on either the mean or volatility of these Argentine domestic bonds,further confirming my hypothesis that the joint issue benefit perceptionsof Argentine credibility directly. In contrast, news about Argentine eco-nomic performance has an impact on the mean of the Boden 2013.28 Somefinancial market controls are significant in both equations.

IMPLICATIONS AND THE FUTURE OF JOINTSOVEREIGN BORROWING

This paper began by describing a unique financial instrument issued bythe Venezuelan and Argentine governments in 2006. I was interested in

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Tab

le5

Arg

enti

ned

omes

tic

bond

sre

gres

sion

resu

lts

EG

AR

CH

Mod

el(G

auss

ian

Dis

trib

utio

n,L

ogL

ikel

ihoo

dE

stim

atio

n)w

ith

Rob

ustS

tand

ard

Err

ors

TAR

CH

Mod

el(G

auss

ian

Dis

trib

utio

n,L

ogL

ikel

ihoo

dE

stim

atio

n)w

ith

Rob

ustS

tand

ard

Err

ors

Dep

end

entV

aria

ble:

Dai

lyC

hang

ein

spre

adof

Bod

en20

13an

dB

oden

2017

Bod

en20

13:2

6O

ctob

er20

06–1

2M

arch

2009

Bod

en20

17:1

6A

pril

2007

–12

Mar

ch20

09

EG

AR

CH

III.

Bod

en20

131,

2TA

RC

HIV

.B

oden

2013

EG

AR

CH

V.B

oden

2017

TAR

CH

VI.

Bod

en20

17

Coe

ffSt

and

.EC

oeff

Stan

d.E

Coe

ffSt

and

.EC

oeff

Stan

d.E

Mea

neq

uati

onJP

Mor

gan

Em

bi–

–.1

991∗∗

.104

1.6

411∗∗

∗.0

713

.466

7∗∗∗

.074

7U

ST-

Bill

10–

––

–.1

270

.098

6−.

1414

.095

5U

ST-

Bill

5−.

0158

∗∗∗

.003

8.0

404

.082

9–

––

–A

rg.E

con

––

−.23

231.

333

––

−.64

95.7

785

Arg

.Dom

Pol

––

1.04

7.9

915

––

.754

9.5

080

Ven

.Eco

n–

–1.

367

2.42

9–

–−5

.307

∗2.

861

Ven

.Dom

Pol

−.44

421.

368

−.42

23.4

997

Ven

.Com

mit

––

−.19

401.

207

––

−.25

34.6

126

Con

stan

t.0

107

0205

.456

8.3

266

.181

2∗.1

016

.386

1∗∗.1

827

Var

equa

tion

Arg

.Eco

n−.

8734

∗∗.3

835

.114

2.4

295

−.04

93.2

133

.343

6.3

809

Arg

.Dom

Pol

.238

0.2

642

−.17

44.4

266

.146

5.0

964

.374

3.6

146

Ven

.Eco

n−.

0543

.445

0.1

085

.683

5.5

525

.335

82.

090∗∗

∗.7

841

Ven

.Dom

Pol

−.26

89.2

523

.233

5.5

167

−.07

81.1

994

.413

1.6

467

Ven

.Com

mit

.411

8.3

814

−.17

82.4

395

−.05

97.3

840

−1.1

06∗∗

∗.4

235

Con

stan

t.2

937∗∗

∗.0

819

3.85

7∗∗∗

.124

2.0

291

.057

12.

013

.157

8G

AR

CH

Sym

.AR

CH

term

−.08

29.0

926

––

.059

3.0

604

––

Asy

m.A

RC

Hte

rm.9

095∗∗

∗.1

169

––

.246

4∗.1

369

––

GA

RC

Hte

rm.9

469∗∗

∗.0

143

––

.986

4∗∗∗

.022

0–

–TA

RC

Hte

rm–

–.5

878∗∗

.258

1–

–1.

396∗∗

.675

1R

esid

ualt

ests

Test

stat

isti

cp-

valu

eTe

stst

atis

tic

p-va

lue

Test

stat

isti

cp-

valu

eTe

stst

atis

tic

p-va

lue

Q(1

2)39

.727

0.48

2464

.133

80.

0091

49.3

663

0.14

7258

.060

80.

0322

Q2 (1

2)14

.129

50.

9999

158.

6002

0.00

0035

.696

10.

6643

209.

6093

0.00

00

Not

es:S

igni

fican

tat1

%le

vel∗

∗∗;S

igni

fican

tat5

%∗∗

;Sig

nifi

cant

at10

%∗ .

(1)

Ico

ntro

lfor

the

five

year

US

Trea

sury

bill

for

the

Bod

en20

13in

stea

dof

the

10-y

ear

T-bi

llbe

caus

eof

the

shor

ter

mat

urit

yof

this

bond

.(2)

Itw

asno

tpos

sibl

eto

incl

ude

the

new

sco

ntro

lsin

the

mea

neq

uati

onfo

rth

eB

oden

2013

asth

em

odel

faile

dto

conv

erge

.

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determining whether, despite the fact that the joint sovereign bond wasa package of bonds rather than a bond with pooled financing, the mar-kets treated it as a joint sovereign bond, or as a more mundane domes-tic issuance. I hypothesized, based on theories of credible commitmentand analysis of the surrounding political conditions in Venezuela and Ar-gentina at the time of issuance, that the market might perceive the bond tocarry an implicit Venezuelan guarantee.

The empirical evidence has demonstrated that the spread of the Bonodel Sur is determined in large part by Venezuelan domestic politics, andthat the volatility of the Bono del Sur increases when there is newsabout Venezuela’s commitment to Argentina and the region, as well asVenezuelan macroeconomics. This is in contrast to other Argentine do-mestic bonds, which respond more strongly to variables related to thedomestic economy and the international credit climate, and not to thoserelated to the Venezuelan economy or foreign policy.

These findings offer two distinct contributions to the literature on cred-ible commitment and sovereign debt. First, they suggest that financialmarkets are aware of the broader political relationships in which sovereignbonds are embedded, and attempts by sovereign states to utilize their exter-nal relations to boost credible commitment. Despite the fact that Venezuelahad no formal obligation to support Argentine debt, markets anticipatedthat the strong political relationship between these two countries wouldbe relevant to the creditworthiness of the bond. It therefore opens new av-enues of research on the impact of political relationships between sovereignstates on the price and volatility of sovereign bonds.

Second, these findings may have practical application in future attemptsto issue guaranteed or joint sovereign debt. The most obvious immediateexample of potential joint sovereign borrowing is Europe, where the on-going sovereign debt crisis requires institutional solutions, including pos-sibly, the issuance of joint sovereign debt (what the European Commissionhas called ‘stability bonds,’ see European Commission 2011).

While it is impossible to comment on the political, economic and legalcomplexities of a European joint sovereign issue in this short space, theanalysis in this article provides some useful preliminary insights. In par-ticular, the example of the Bono del Sur suggests that the depth of thepolitical and economic relationships between Eurozone members makesit more likely that any such instrument will trade on the basis of the eco-nomic performance of the ‘anchor’ state (most likely in this case to beGermany) and the political dynamics surrounding their commitment tothe instrument. Thus the risk for joint European debt would lie not in theaverage spread, which would likely be driven by German macroeconomicfundamentals, but rather in the politicking that would surround the in-strument. Negative perceptions by the market towards the commitmentto finance these bonds would reflect poorly in the instruments’ volatility.

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These hypotheses are similar to those of the European Commission, whohas suggested in the context of their proposal for joint European ‘stability’bonds that:

The more extensively credit risk would be pooled among sovereigns,the lower would be the market volatility . . . [but] some of the pre-conditions for the success of Stability Bonds, such as a high degreeof political stability and predictability or the scope of backing bymonetary authorities, go well beyond the more technical domain.(European Commission, 2011: 4)

To conclude, this article has shown that Venezuela and Argentinasuccessfully issued a bond which changed investor perceptions aboutArgentina’s credible commitment despite its conservative structure. Itprovides insight into the way that sovereign states can use external re-lationships to enhance international perceptions of creditworthiness, andmore specifically, the political economy of joint sovereign borrowing.

NOTES

1 The online magazine Latin Finance commented: ‘Venezuela and Argentina havefinally launched the much-heralded ‘Bono del Sur’. In the end, it was not somuch a jointly issued bond as three bonds grouped together’. Latin Finance, 9November 2006.

2 The total value of the bond was $1 billion, which included $500 millionVenezuelan TICC maturing in 2017, $300 million of an Argentine Boden ma-turing in 2012, and $200 million Boden 2015. Both the Boden 2012 and 2015 hadbeen previously issued by the Argentine government (in 2005), and some ofthese bonds had been previously purchased by the Venezuelan Central Bankthrough a financial aid mechanism discussed on page 7 of the paper.

3 The second tranche, issued in February 2007, had a total value of $1.5 billionand was composed of $750 million TICC 2019 and an equal amount of theBoden 2015. The third tranche was launched in September 2007: $600 millionof Boden 2015 and $600 million of TICC 2015.

4 The most comprehensive proposal for joint European sovereign debt to datehas been written by the European Commission (European Commission, 2011).This follows on much previous speculation and analysis amongst market par-ticipants, financial journalists, academics and European think tanks.

5 Drazen is interested in credible commitment in an array of policy settings,not only in sovereign debt (Chapter 4). His book explores the ways that theseproblems have been solved through both institutional design (Chapter 5) andreputation (Chapter 6).

6 The IMF has often cited its role in catalyzing private flows as a resolutionto crises. See for example a speech given by first managing director Stan-ley Fischer in 1999 (available online at http://www.imf.org/external/np/speeches/1999/120999.HTM) or a 2001 IMF Factsheet entitled ‘The IMF

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http://www.imf.org/external/np/speeches/1999/120999.HTM

http://www.imf.org/external/np/speeches/1999/120999.HTM


and the Private Sector’ (http://www.imf.org/external/np/exr/facts/privsec.htm). Both citations from Edwards 2006.

7 Note that while this quote is given in a number of articles, this author could notlocate the quote in its original setting. In a 1987 paper entitled ‘InternationalMacroeconomic Policy Coordination’ (NBER Working Paper no. 2244), Fischerstates that ‘The EMS can be viewed as an agreement by France and Italy toaccept German leadership in monetary policy, imposing constraints on theirdomestic monetary and fiscal policies’ (Fischer, 1987: 41).

8 See Annex 3 of European Commission 2011, ‘Green Paper on the Feasibility ofIntroducing Stability Bonds’.

9 Pearson, N. O. (2007, March 15). ‘Chavez says Venezuelan Aid to Latin AmericaSurpasses US’, Associated Press.

10 Cuban teachers and doctors were sent to Venezuela in exchange for access todiscounted oil (Shifter, 2006: 52).

11 Pearson, N. O. (2007, March 15). ‘Chavez Says Venezuelan Aid to Latin AmericaSurpasses US’, Associated Press.

12 Thompson, A. (2007, January 7). ‘Venezuela Aid to Cement Ortega Ties’, Finan-cial Times.

13 Mander, B. (2006, July 11). ‘Latin Allies Forge Political Bond’, Financial Times.14 There is limited transparency in the sovereign bond markets, and it is not pos-

sible to map over time who the holders of a given bond are. However, spot datacan be obtained. Spot data from December 2011 suggests that the 30 largestregistered holders of the Boden 2015 (Argentine component of the Bono delSur) are based in the US or Europe. They are, in descending order of shareof the bond held: Alliance Bernstein, Franklin Resources, Putnam Investment,Oppenheimer Funds, Fidelity, Capital World Investments, Morgan Stanley &Co, Alliance Berstein LP, Blackrock Investments and Massachusetts Financial.These 10 companies hold 17 per cent of the bond; all registered international in-vestors hold approximately 22 per cent of the bond. This compares favourablyto other domestic Argentine dollar denominated bonds (such as the Boden2013 and 2017), whose internationally registered holdings amount to about 11per cent and 6 per cent. This provides a good deal of comfort that changes tothe price and volatility of the Boden 2015 are due to the changing risk appetiteof international investors, as any government holdings are not expected to beactively traded.

15 See for example Webber, J. (2011, May 22). ‘Argentina is a Risk Worth Taking’,Financial Times.

16 The extent to which the Argentine government sympathized with broaderVenezuelan goals towards regional integration is, however, debatable. Someauthors have argued that Kirchner and Chavez came from the same ‘branch’of the Latin American left, characterized by a populist, authoritarian visionthat contrasts with the pragmatic left in other countries of the region (e.g.,Brazil, Uruguay and Chile; see Casteneda, 2006; Reid, 2007; Santiso, 2006). Incontrast, others have argued that the relationship is more utilitarian: acceptingVenezuela’s ‘attractive economic deals without really endorsing his agenda’(Shifter, 2006: 53–4).

17 I do not directly compare the spreads or price of the Argentine Boden 2015 toother dollar denominated domestic bonds because the difference in the bondsmaturity structures has a significant impact on the level of their spread/yield.

18 I do this by differencing the log of today’s spread with yesterday’s spread,and multiplying by 100. The transformed dependent variable rejects the nullhypothesis of a unit root.

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http://www.cfr.org/economics/venezuelas-oil-based-economy/p12089



19 Results omitted for reasons of space, but are available upon request to theauthor.

20 Adjustments are made when the news occurs on a Monday or the previousday was a non-trading day for any other reason (e.g., a national holiday).

21 See for example: Wall Street Journal (2006, June 7). ‘Anybody But Chavez’, WallStreet Journal, p. 11, and Wall Street Journal (2008, August 21). ‘Banana RepublicBehavior, Cont.’, Wall Street Journal, p. 11.

22 The shortcoming of utilizing the FT as my main source of data is that by beingan international financial newspaper, it does not report all domestic political oreconomic news about these two countries but rather reports only what couldbe considered ‘major’ events, which may introduce some bias in the results.In particular, it might under-emphasize the importance of some data (due tounderreporting of news), and over-emphasize others (making major eventsappear to be even more important).

23 The coding methods are consistent with previous studies. Using Lexis Nexis, Irun a search in the Financial Times during the period of interest to see howoften the names of the countries or leaders appear in the headline of FTstories (‘Venezuela/Venezuelan’, ‘Argentina/Argentine’, ‘Chavez’, ‘Kirchner’and ‘Fernandez’, as Cristina Fernandez de Kirchner, Argentine president from2007–present, is referred to by that name on several occasions).

24 A Lijuing-Box test rejects the null hypothesis that the data are random (not auto-correlated) with up to 50 lags. A Portmanteau test for white noise suggests thatthere is autocorrelation; the Portmanteau test for white noise for the GARCH(1,1) model rejects the null hypothesis.

25 A Jarque-Bera test for skewness and kurtosis rejects the null hypothesis of anormal distribution, as does a skewness/kurtoisis test for normality.

26 I have not tested Markov switching models (an alternative estimation techniqueoften used in similar studies) in this paper because of the robust comparisonbetween the two models completed by Leblang and Mukherjee (2004) thatsuggests GARCH models are more efficient.

27 Leblang and Mukherjee (2005) and Bernhard and Leblang (2006b) test theimpact of political variables on both the mean and volatility. Political variablesare significant in the mean equation only in the first study.

28 There are several reasons why this might be the case. As mentioned in foot-note 14, there is limited international holding of the Boden 2013 and 2017 andthey are therefore relatively illiquid and infrequently traded. This might makethe bonds unresponsive to news that would usually affect domestic bonds,such as news about domestic politics and economics. I do not believe that thisundermines the conclusion that these bonds fail to respond to news aboutVenezuelan regional commitment, however, as the variable is strongly signif-icant in the volatility equation for the Boden 2015 (Table 4), and would likelyhave an impact even on more illiquid bonds like the Boden 2013 and 2017.

NOTES ON CONTRIBUTOR

Lauren M. Phillips is a lecturer in international political economy at the LondonSchool of Economics and Political Science (LSE) in the Department of InternationalRelations. She holds undergraduate and master degrees from Stanford Universityand a PhD from the London School of Economics, awarded in 2006. She joined theLSE faculty in 2008. Her research is focused on sovereign debt, financial marketperformance and political risk; she has long been interested in the Latin Americanregion.

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APPENDIX

News about Venezuela’s Commitment to Regional Integration26/10/2006–12/03/2009Source: Financial Times

Date Reported Article Title and Brief Summary

17/10/2006 “Mud-slinging sets tone for Ecuador run-off:” Chavez allylosses ground in Ecuador poll; “Chavez’s UN ambitionssuffer blow:” Venezuela backs Bolivia for Security Council

03/11/2006 “Big blow to Chavez as Panama takes vacant SecurityCouncil seat:” Panama takes security council seat againstVenezuelan preferences; “Ortega gives Washington thejitters as he scents victory in Nicaragua election:”Relationship between Daniel Ortega and Hugo Chavezstrong

28/11/2006 “Correa’s triumph The US should learn to live withChavez’s new ally:” Chavez ally wins Ecuadorian poll

09/12/2006 “Chavez victory bolsters Cuba’s succession hopes:” Chavezintervention in Cuban succession

08/01/2007 “Venezuela aid package to cement ties with Ortega’sNicaragua:” Venezuela announces aid for Nicaragua

12/01/2007 “Chavez outlines aid program for Nicaragua”20/01/2007 “Mercosur frustrates extension of Chavez influence:”

Mercosur delays Venezuelan membership23/03/2007 “Washington restive as Chavez plans pioneer bank:” Chavez

announces plans for Banco del Sur13/04/2007 “Venezuelans learn to love the bond:” Venezuelan purchases

of bonds, including Bono del Sur08/05/2007 “Argentine group seeks to fend off Chavez threat:” Tension

between Venezuela and Argentina over nationalization25/09/2007 “Bond of the South III ’will fail to drain Venezuelan

liquidity”09/10/2007 “Chavismo’s limits:” Chavez ally in Ecuador consolidates

position(Continued on next page)

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Date Reported Article Title and Brief Summary

07/12/2007 “Chavez and allies bank on lender to rival Washington:”Meeting to sign into place Banco del Sul

13/12/2007 “‘Agents of Venezuela’ accused of plot to manipulateArgentina poll”

21/12/2007 “Venezuela boosts Cuba’s economy”06/03/2008 “Caribbean debates benefits of links with Venezuela:” ALBA

membership divisive14/07/2008 “Venezuelan largesse:” Guatemala formalizes relationship

with Venezuela’s Petrocaribe21/07/2008 “Chavez widens cheap oil finance network:” Central

American countries joining up for cheap Venezuelan oil18/09/2008 “Prodigal Chavez turns up the heat:” Central American

cheap oil deals completed18/12/2008 “Venezuelan effort to find allies against US runs out of gas:”

Aid program vulnerable in light of oil price collapse27/01/2009 “Oil price fall curbs Chavez revolution:” Abrupt fall in oil

price means less money for foreign aid program

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The politics of joint sovereign borrowing: The Venezuelan/Argentine Bono del Sur

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