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Credit Risk Spreads in Local and Foreign Currencies




  • We wish to thank Zvi Bodie, Michel Crouhy, Rick Levich, Haim Keidar-Levy, Benzi Schreiber, and Tony Saunders for their insights and especially Daniel Hardy for his helpful suggestions and fruitful discussions, as well as the participants of the seminars on Risk Management in Moscow and Almaty, NUS in Singapore, University of Piraeus, University of Melbourne, University of New South Wales, the Fifth World Congress of Bachelier Finance Society, and the IMF. We benefited from the great editorial assistance of June Dilevsky. The comments of the editor and two referees were invaluable in revising the paper. We acknowledge financial support from the Zagagi Center and the Krueger Center at the Hebrew University. The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

Dan Galai is the Abe Gray Professor and the Dean of the School of Business Administration at The Hebrew University of Jerusalem (E-mail: Zvi Wiener is an Associate Professor at the School of Business Administration, The Hebrew University of Jerusalem (E-mail:


Governments, corporations, and even small firms raise and denominate capital in different currencies. We examine the micro-level factors that should be considered by a borrower when structuring debt denominated in various currencies. This paper will show how the currency composition of debt affects the cost of debt through the interaction with the risk of company's assets. We look at the currency mismatch in the firm and analyze its credit spread within a Merton's type model with bankruptcy. We show that foreign currency borrowing is cheaper when the exchange rate is positively correlated with the return on the company's assets. The determining factor is not just whether a given company is an exporter or importer, but rather the statistical correlation between the rate of return on the firm's assets and changes in the exchange rate.