| China is, and will be for some time in the foreseeable future, in the process of urbanization. During that process, a large number of rural population flocked to cities, giving rise to huge demand for public utilities and infrastructures. Due to the fact that urban construction products are of a highly public nature, private capitals are rarely attracted, local governments for a long time are left to assume the responsibility of urban construction investment. Under normal circumstances, it is impossible for local governments to meet the large amount of investment required for urban construction using their daily budgets. In the experience of developed western countries, municipal bonds are one of the common methods used to raise funds for local urban construction. However, under China’s existing legal and regulatory framework, central government has placed severe restrictions on local governments in raising debts. As a result of the contradictories between the pressure to raise funds for urban construction and the severe restrictions under laws and regulations, many local governments seek to "set up a urban construction firms with the specific responsibility of urban construction, and raise funds using such firms as a financing platform". In 2005, the Development and Reform Commission lowers the threshold for corporate bonds, which presented an opportunity for direct financing. The 2009 the central government’s adoption of loose monetary policy and active fiscal policy, the volume of financing of local quasi-government bonds have grown as construction projects financed by local governments commenced. The issuance of local quasi-government bonds encountered an unprecedented peak during the periods from 2009 to 2012. As of December 31,2012, the balances local quasi-government bonds traded in China inter-bank market has arrived to about RMB144 billion.Secondly, as a special alternative financing tool arising as a result of existing economic environment and legal and regulatory, quasi-government bonds, despite their rapid growth in size, have begun to show some of drawbacks, most notable of which are the credit risks associated with it:urban construction investment firms themselves do not have strong prospect for profitability, and therefore have to be partly financed by local governments, and their ability to repay is in actuality dependent on the credit of local governments. Meanwhile, as local government debts continue to expand, the creditworthiness of local governments is beginning to trigger concerns.As local quasi-government bonds has became an important part in Chinese capital market, it is of practical significance to measure and control its credit risk, for protecting investors" interest or for prevent local government’s debt crisis led by its over-financing behavior. On the other hand, along with the loosing of central government’s policy, the possibility that local governments are permitted to directly issue municipal bonds has increased (local government bonds issued on behalf by department of treasury can be considered as a start point of this trend), thus the deep research on local quasi-government bonds could also provide beneficial reference for the design of future municipal bonds in China.This paper adopted a combination of theoretical research and empirical research. The Part I of this paper mainly discusses the background and significant of the research and gives an overview of the framework and thinking methodology in the research. During the work, the author has the opportunity to access a huge amount of relevant literature and research, including western scholars’work on municipal bonds and Chinese scholars’research on local quasi-government bonds and related issues about financial risks in local government level. The author’s research ideas was beneficially expanded by reading these former’s works. These works, as the basis of this paper’s theoretical background, are summarized in Part II of this paper. Part III and Part IV mainly involve in the introduction of western municipal bonds (using U.S municipal bonds as example) and local quasi-government bonds in China, as well as the similarity and difference between them. The focus in these two parts are risk control experience about U.S municipal bonds and commonly-used credit enhance practice in China market.Part V and Part VI are the key areas of this paper. In Part V, after introducing and comparing some commonly-used credit risk measures and models, the author chooses to construct the credit risk model for local quasi-government bonds on the basis of KMV model, and uses the default probability generated by above KMV model ("KMV default probability") as the standard to measure the default probability of local quasi-government bonds. In Part VI, an empirical study on the KMV model constructed in Part V is performed. As there is no historical default occurred since the birth of local quasi-government bonds in China, the empirical study in Part VI focuses on the bond’s KMV default probability(calculated using KMV model constructed in Part V along with historical data and Matlab Tools) and its interest spreads(difference between coupon rate and market interest rate at issuance). If in the empirical study there is a significant positive correlation between KMV default probability and interest spread, which means the market participants require a higher compensation for the local quasi-bonds with higher KMV default probability, and it is concluded KMV default probability is a good indicator for local quasi-govemment bonds" credit risk. A total of 418 samples of local quasi-government bonds issued by prefectural-level governments from 2008 to 2012 are selected for empirical study. Besides credit risk, the interest spread could also be influenced by a number of other macro/micro factors, thus, some other variables other than KMV default probability are also incorporated in the regression model constructed for empirical study. To exclude possible col-linearity among these variables, backward stepwise regression methodology was adopted to construct a multiple regression model. The study result shows that the constructed multiple regression model has good R-squared and can effectively explain the change in interest spread. At the same time, the variable of KMV default probability has passed T-test at the 95% confidence interval, which indicates that KMV default probability has a significant positive correlation with the interest spread and it is concluded KMV default probability is a good indicator for local quasi-government bonds credit risk. Part VII is the sum up of the whole paper. The author also uses this part to propose his policy recommendations to improvement the risk management of local quasi-government bonds. |
