AN APPLICATION OF THE ARBITRAGE THEORY OF CAPITAL ASSET PRICING TO THE SYNDICATED EUROCURRENCY CREDIT
The syndicated Eurocurrency credit is a line of credit provided by a group of financial institutions (primarily, but not always, commercial banks) to a single borrower. Typically, the rate of interest is quoted as a "spread" over Libor, the London Interbank Offered Rate. Anecdotal evidence suggests that spreads reflect lenders' risk perceptions: prime borrowers enjoy narrow spreads, while more risky customers are charged larger spreads. The spread, therefore, appears to be a risk premium. Models of efficient capital markets suggest that risk premiums will reflect sensitivity to systematic risk factors. The Sharpe-Lintner Capital Asset Pricing Model (CAPM) argues for one systematic factor, while, more recently, Roll and Ross have argued for the more general Arbitrage Pricing Theory (APT) in which risk premiums reflect the influence of several systematic risk factors.^ In this study, I have applied the APT of Roll and Ross to the market for syndicated Eurocurrency credits. My null hypothesis is that this model can be used to explain the observed cross-sectional differences in ex ante spreads. The identity of these systematic risk factors was discussed, and it was determined that the global business cycle, the strength of the U.S. dollar in foreign exchange markets, the level of Eurodollar interest rates and the price of oil worldwide are the most likely sources of systematic risk in syndicated Eurocurrency lending. Empirical results were obtained via Factor Analysis of spreads over the period January 1972 to June 1981. The FA results indicate that there are at most two factors that systematically influence spreads. There is no evidence from the FA that four systematic risk factors are present in ex ante spreads.^ The second stage of the empirical study, the cross-section regression of spreads on estimated factor loadings, indicated that, at best, only one factor was priced, but the estimated coefficient was of borderline significance and of the wrong sign. Therefore, the applicability of the APT was drawn into question, and the conclusion was reached that spreads on syndicated Eurocurrency credits were not priced according to sensitivity to systematic risk factors, or, at best, showed little evidence of this influence on pricing, over the period studied. ^
TOBIN, JOHN MICHAEL, "AN APPLICATION OF THE ARBITRAGE THEORY OF CAPITAL ASSET PRICING TO THE SYNDICATED EUROCURRENCY CREDIT" (1985). ETD Collection for Fordham University. AAI8521419.