Effect of Country Risk on Yield Spreads in Kenyan Eurobonds

Abstract

This study aimed at examining the effect of country risk on yield spreads in Kenyan Eurobonds. The spreads in this case represented a premium paid on the Eurobonds in comparison to yields on similar bonds in the international markets. The Modern Portfolio Theory, the Efficient Market Hypothesis theory and the Arbitrage Pricing Theory were adopted as the key theories for the study. The study carried out a census of the six outstanding sovereign Eurobonds issued by Kenya since 2014 and collected and analyzed data for a period of 7 years since 2014. The key economic fundamentals used to determine Country Risk were also examined to determine their individual effect on yield spread. These are the Debt-to-GDP ratio, Foreign Exchange Reserves, Inflation rate, GDP growth rate and Exchange rate volatility. Analysis of data was carried out through descriptive statistical techniques, correlation analysis and the multiple linear regressions. The study found a strong negative relationship between yield spread and GDP growth and a positive relationship between Exchange rate volatility and yield spread. Overall Country Risk, level of Foreign Exchange Reserves, Inflation Rate and Debt-to-GDP ratio however didn’t have a significant relationship with yield spread suggesting the premium paid on Kenyan Eurobonds was not in line with underlying economic fundamentals and the overall country’s risk profile. The study therefore recommends that the Kenyan government ensure that the yield charged on its external borrowing is quantified against the country’s overall risk profile and is not based on investor bias. This is expected to result in savings which could better be used on development projects, benefitting Kenyans at large.