Explaining interest spreads on sovereign Eurodollar loans: LDCs versus DCs, 1978–84

Abstract

The purpose of this paper was to estimate equations relating spreads above the London Interbank Offer Rate (LIBOR) charged on sovereign-guaranteed private Eurodollar loans to various indicators of default risk for both lesser developed countries (LDCs) and developed countries (DCs). The Study focused on the period 1978–84 using sample loan data of 27. LDCs and 14 developed countries. The results suggest that spreads charged to LDCs are functions of indicators reflecting default risk, while spreads charged to DCs are to a lesser extent. Holding defult risk constant across both LDCs and DCs, a statistically significant gap in the average interest spreads favours DCs. This gap was subsequently explained by variables reflecting investment return from borrowed capital. Significant differences in risk coefficients between LDCs and DCs still persisted for the terms of trade, the debt-service–exports ratio, the investment–GNP ratio and the debt–GNP ratio.

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