February 28, 2014
PRELIMINARY VERSION
DO NOT QUOTE OR CITE WITHOUT THE AUTHORS’ PERMISSION
STEPHANIE COLLET#
KIM OOSTERLINCK#
Lending Money to the “Executioners1”: The Case of the
1906 Russian Loan
ABSTRACT
The impact of sovereign debt repudiation is relatively well documented. The market reactions to
warnings regarding a repudiation have however never been investigated. Are organized protests
and the threat of a possible future repudiation perceived as credible by the markets? This paper
analyzes the case of the Russian 1906 loan. Protests were staged against the loan which was
viewed by the opposition to the autocratic tsarist regime as a loan which would help a despotic
regime to further pressure its people. The paper shows that the market required a premium to
hold such a controversial loan, and this despite the attempts made by the Russian government to
present the loan as clean.
JEL Codes: F34, G12, G15, N23
Keywords: Repudiation, Financial History, Sovereign debt, Russia
#
ESCP Europe, Finance department, 79 av. de la république, 75011 Paris, France, [email protected].
Université Libre de Bruxelles, SBS-EM, 50 av. Roosevelt, CP 114/03, 1050 Brussels, Belgium,
[email protected].
1
“Ne donnez pas un sou aux bourreaux du people russe, bourreaux de corps et bourreaux d’esprits!” (Do not
give a penny to the executioners of the Russian people, executioners of the bodies and of the minds). Excerpt of
Gorki’s appeal against the 1906 Russian loan published in L’Humanité, 9 April 1906.
#
1
Lending Money to the “Executioners”: The Case of the
1906 Russian Loan
I.
Introduction
Sovereign bonds are, by nature, complex instruments. Even though the sovereign status
should prevent any bondholder to sue the sovereign state in case of default, bondholders tend to
view sovereign debts as safe assets. Indeed, the sovereign status of the issuer means that
reimbursement is basically conditional on the state’s willingness to pay. A huge literature has tried
to understand states’ motivations to repay. Reputation has been presented as one of the key
reasons states repay their debts (Eaton and Gersovitz, 1981). Bulow and Rogoff (1989), as well as
Rogoff and Zettelmeyer (2002), show that additional costs to the defaulting state also play an
important role. Flandreau and Zumer (2004) analyze the penalty paid by defaulters during the
gold standard period. They find that once a settlement was reached the state was only penalized
in a very limited way thereafter.
Alternative explanations have also been suggested. These explanations usually rely on a third
party: foreign bondholders associations, underwriters or states where the bonds were held. The
role of foreign bondholders associations has for example been investigated. Esteves (2007)
suggests that their quality had a direct impact on the achieved settlement and on the costs of
negotiation. Flandreau, Flores, Gaillard & Nieto-Parra (2009) analyze in depth the role of
underwriters. They show that for the 19th century defaults were not random across underwriters.
The role of underwriters at the time was in fact double. They were providing liquidity (as
nowadays) but also a signal regarding the quality of the issuer. Underwriters had thus a
certification role (Flandreau and Flores, 2010). They had a strong incentive to preserve their
reputation even if it meant that they would have to play the role of lender of last resort. Military
interventions have also been suggested as a means to force states to behave. The early literature
2
on this topic tended to reject the impact of military intervention noting that many defaults were
not followed by gunboat diplomacy. Mitchener and Weidenmier (2005) show however, in the
framework of the Roosevelt Corollary (1904), that a credible threat of intervention had a clear
and direct impact on sovereign bond prices. Thus the actual intervention didn’t have to
materialize at each default as long as the threat of intervention remained credible. Mitchener and
Weidenmier (2010) build on this work to develop the concept of supersanctions: extreme heavyhanded sanctions imposed upon a defaulting state. According to their analysis, these
supersanctions (which included on top of gunboat diplomacy, fiscal house arrests) were common
during the gold standard.
The literature on sovereign debts has thus been able to identify motivations to repay. In fact
however, it is not just states who decide to repay a debt or not, but governments. In extreme
cases governments may decide to repudiate sovereign debts because they judge these illegitimate.
These decisions, linked to extreme events, are rare in nature and mark a willingness from the new
government to break away from the past. Since occurrences of repudiations are so infrequent,
one could believe that markets hardly price such an event before it occurs.
This paper aims to analyze whether bond markets price repudiation risk when there is a
credible threat of repudiation. History provides an ideal example of such a credible threat. In
1906, the tsarist government issued a bond on several European exchanges. This bond was
fiercely attacked by several preeminent political leaders as it was viewed as a means to support the
political repressions set into place by the despotic tsarist regime. In the framework of these
attacks, the future repudiation of this given bond, should the opposition take power, was
repeatedly mentioned. The threat proved to be credible when the 1917 Russian revolution all
tsarist debts were repudiated. To determine if markets priced the repudiation risk specific to this
bond, we track its price and compare it on the long run with another Russian sovereign bond
3
which had not been subject to repeated attacks. Results indicate that indeed the mere threat of
repudiation was enough to make bond prices dip, showing that investors did require a substantial
premium to cover the repudiation risk. The required premium also increased when the
repudiation eventually took place.
The balance of the paper is organized as follows. The next section (II) reviews the literature
on bond prices and repudiation. Section III discusses the political context of the 1906 issue, as
well as the protests staged at the time. Section IV presents the data and the empirical
methodology. Section V discusses the results and concludes.
II Bond Prices & Repudiation
Repudiations before 1906
Repudiations, the refusal to recognize the legal character of a debt, may be traced back to
medieval times. However before the Russian revolution, repudiations were rather uncommon
(Borchard, 1951). One may thus wonder how familiar bondholders were with concept and its
implications. It is however important to distinguish the repudiations which occurred before 1917
and the ones happening thereafter. The shock caused by the Soviet repudiation of tsarist bonds
as well as the huge amounts involved transformed radically the perception of repudiation risk on
the markets (Landon-Lane and Oosterlinck, 2006, Oosterlinck and Ureche-Rangau, 2008).
Before 1917, several cases are worth mentioning. In 1834, bonds issued by Dom Miguel
during the Portuguese civil war were repudiated by the victorious Maria II. In 1867, the debts
issued by Maximilian I of Mexico were repudiated by Benito Juarez when he took over power. In
both cases, the debts were declared illegal since both Maximilian I and Dom Miguel were viewed
4
by their successors as usurpers. Several US states repudiated their debts during the 1840’s. In this
case however, the motivation to repudiate was not a change in government but rather linked to
the complex scheme which had lead states to guarantee bonds issued by banks or to provide
these banks with state bonds. According to English (1996) government which repaid their debts
did so in order to be able to maintain access to capital markets. The US civil war provides
another case when bonds issued by the defeated party were repudiated after the war. Oosterlinck
and Weidenmier (2007) show that holders of Confederate bonds knew that in case of a Union
victory they would not be reimbursed. They use this element to reconstruct the perceived
probabilities of a successful and lasting secession.
Repudiation could also be linked to state succession. An early example of such a repudiation
occurred in the framework in the Spanish American War. The practice at the time was for the
victor who annexed a territory to take over the debts associated to this territory (Hoeflich, 1981).
The victorious US government created a precedent when it refused to take over the Cuban debts.
The main argument advanced at the time was the odious character of these debts. They had been
issued neither with the consent nor for the benefits of the Cuban people. Collet (2011) shows
that the market required a substantial premium to hold the Cuban bonds which were viewed by
the market as most likely to be repudiated.
Market reactions and potential feelings towards repudiation risk
Before 1906, markets reacted very negatively when debts were repudiated. The price of the
Confederate bonds converged to a close-to-zero value. The Portuguese issue remained traded on
the Paris bourse but at a very large discount and this up till a settlement was reached in the 1890s.
Cuban bonds also experienced a dramatic price decline. The bonds issued by Maximilian were the
only ones for which the haircut was mitigated. This was due to the intervention of the French
5
government which agreed to bailout bondholders by paying approximately 50% of par value. The
intervention of the French government had, at the time been made, because the regime of
Napoleon III had strongly supported the issue of these bonds on the Paris bourse. The high
profile of the French government led it to recognize some form of responsibility towards French
holders of these Mexican bonds.
The real turning point regarding repudiation came in 1917 when the Soviets refused to
recognize the tsarist debts. At that time, the French bailout of Maximilian bonds was still
remembered and it played a role in investors’ risk perception. Bernal et al (2010) show that
following the 1917 revolution Russian bonds traded in France fetched higher prices than the
same bonds traded in London whereas before prices were not statistically different. Landon-Lane
and Oosterlinck (2006) analyze the price evolution following the Soviet repudiation. They find
that bond prices remained extremely high in view of the repudiation. They attribute this
observation to a Peso Problem. Bondholders were expecting events to take place which never
materialized. Ex post prices seem thus high even though there were rational reasons explaining
this level. Most notably, French bondholders were expecting: a change in power in Russia, a
change in position of the Soviets, a French bailout and a (partial) bailout from one or more
countries which were born out of the ruins of the Russian empire. None of these events
materialized and from 1917 on bondholders would see a series of communist regimes reneging
on debts issued by their capitalist predecessor. In fact, the risk that a regime hostile to the
previous one would take power had a direct impact on French bond prices during WWII. Indeed,
Oosterlinck (2003) compares the price evolution of two French bonds, one issued during the
Third Republic, and one under Vichy France. He finds that bondholders were requiring a
premium to hold the bonds issued by the collaborationist Vichy regime. Breakpoints on this
premium were mostly linked to the perceived legitimacy of the regime.
6
In 1906, French bondholders knew thus that repudiation was a real risk. A few historical
examples had indeed shown that even though they were uncommon, repudiations were a reality
to take into account. They could also factor in the likelihood that the French government would
bail them out if it had been strongly involved with the bond issue. In all cases bondholders had
been faced directly with repudiations not with threats of repudiations issued by politicians
opposing the ruling regime. In the case of the 1906 loan however, threats were voiced which
would only materialize eleven years later. Did bondholders expect a different treatment for this
loan compared to the other Russian bonds? The next section will describe the context in which
the 1906 loan was floated, the following providing an answer to this question.
III.
The 1906 loan...
Russian bonds and International Context
In April 1906 the Russian government floated a loan on several European stock exchanges;
the serial numbers of each bond being specific to a given stock exchange2. According to
Freymond (1995), the Paris stock exchange received the bulk of the issue (72% of the total
amount). Russian bonds were, by 1906, commonly exchanged on the Paris bourse. In France, the
first significant Russian loan was floated in 1888, many years before the Franco-Russian alliance
which was signed in 1892 (Girault, 1973). Following the repudiation, a census was held to
estimate the number of holders of Russian bonds. It showed that the 52 Russian sovereign debts
quoted on the Paris Bourse were held by close to 1.6 million Frenchmen. Girault (1973, p. 24)
estimates that these loans represented nearly 11,720 million francs. According to Ukhov (2003),
almost half of all Russian sovereign debts were held out of Russia in 1913.
2
The series with a number between 1 and 273 were traded in Paris (with those between 241 and 273 also
exchanged in Vienna), those between 274 and 339 in London and those from 340 to 350 in Amsterdam.
7
The nature of the debts differed between countries. France, Netherlands and Switzerland
held mainly debt issued before the war. Those debts had been contracted to enable the Russian
economic development (Flandreau 2003). On the other hand, the United Kingdom held mainly
war debts. These war debts consisted of advances made by Russia’s Allies during the First World
War (De Monzie, 1931, pp.256-257, White, 1985, pp. 26-28). This difference explains why the
United Kingdom was Russia’s largest creditor at the end of the war (Eliacheff, 1919, p. 131). In
short, Russian bonds were traded mostly in France but also in Belgium, Germany, The
Netherlands and the United Kingdom.
In France, several reasons have been advanced to explain the success of the Russian bonds.
Russian agents in Paris heavily bribed the corrupted French press to be presented in a rosy way.
For example, the French government asked the Russian government to pay the press to reduce
the magnitude of the negative news concerning the Russia-Japanese war and the 1905 revolution
(Long, 1972). According to Long (1972), 2.5 million francs were spent from 1904 to 1906. On 11
February 1904, Russian debt price went sharply down (Raffalovitch, 1931, p. 20). To save the
situation, the imperial government corrupted the press rather than engaging in repurchasing
bonds (Raffalovitch, 1931, p. 24). Bignon and Flandreau (2011) analyze the economics of the
French financial press at the time. They show how Russia used the press to limit the impact of
the negative news from the Russo-Japanese war on its bond prices. To do so, Russian agents
bought space from the journals to publish financial information related to its bonds (for example
drawing numbers for lottery bonds). In this way they were actually buying the collaboration of
these journals. Bignon and Flandreau (2011) estimate that on average for the critical years 1905
and 1906, le Rentier had two out of sixteen pages devoted to Russian bonds. The press was not
the only one to benefit from the “generosity” of the Russian empire. The head of the Paris
bourse as well as the French finance minister also received their share of bribes.
8
The success of these bonds was also partially due to political reasons. After 1890, France and
Russia became gradually closer. The Franco-Russian Alliance (ratified on 17 August 1892) and
the alliance (ratified in 1904) between France and the United Kingdom, gave birth to the Triple
Entente in August 1907. As a result, French companies were encouraged to invest in Russian
bonds in order to sustain its industrialisation (Oosterlinck, 2008).
Financial reasons also played a major role in the Russian sovereign debts success. First,
Russia has vast natural resources. Moreover, Russia was viewed as a huge potential market given
the geographical size of the country. Russian debts also enjoyed a good reputation. They were
intended to boost the economy by developing infrastructure and local industry, both generators
of income (Flandreau 2003). At that time, the Russian bonds performed better than for instance
3% French annuities. Banks also strongly supported Russian loans since they were paid not only
a commission for issuing loans but also a fee to manage the liquidity provided by the Russian
Treasury to pay the coupons (Girault, 1973, p.34)
The 1906 loan: Political Context and Organized Protests
Even though Russia was used to placing international loans, it faced an extraordinary
opposition when it tried to float a new issue in 1906 (Long, 1972). The opposition was such that
the lead underwriter, the Crédit Lyonnais, held a secret meeting with the representatives of the
Tsar to decide whether to pursue the issue (Bayle, 1997). Part of the opposition threatened to
repudiate the loan should they come to power. The strong opposition to this loan can easily be
explained by the Russian political context at the time.
In the 1890s Russia experienced bad harvests which in turn lead to famine. By the end of
1892, famine, cholera and typhus had together killed half a million people (Figes, 1997, p. 158).
9
The slow and clumsy answer provided by the regime proved to be disastrous. Its attempts to
minimize the size of the problem only fueled the populations’ resent. Soon rumors of
governmental conspiracy appeared. In view of the growing importance of the famine, the
government was however forced to change its policy and recognize the extent of the problem.
Following an imperial calling, voluntary organizations were set up to cope with the famine. The
government’s inability to deal alone with the famine had long-lasting repercussions: “the conflict
between the population and the government had been set in motion – and there was no turning
back” (Figes, 1997, p. 162).
The beginning of the twentieth century saw no diminution in the tension between the state
and the street. Students’ demonstrations erupted in January 1901. The political response was to
draft the leaders of the movement leading to more unrest, terrorist actions and heavy repression.
The outbreak of the war with Japan in January 1904 thus came in a period of extreme internal
tensions in Russia. The Tsar was convinced Russia would without any problem end up being
victorious (Figes, 1997, p. 168). Military operations were to prove him wrong: the incompetence
of the Russian military commanders as well as the poor equipment of the soldiers could only lead
to a bad outcome for Russia. Political tensions within Russia escalated as the war progressed. The
unpopular Minister of the Interior, Viatcheslav Konstantinovitch von Plehve, after surviving
several assassination attempts was eventually killed in July 1904.
At the end of the year 1904, representatives of many zemstvos (local governments) met to
discuss reforms and produced resolutions which were questioning the legitimacy of the autocratic
tsarist regime. The new Minister of the Interior, Prince Sviatopolk-Mirsky, attempted to get the
Tsar to listen to these complaints but to no avail. In January 1905, a massive number of workers
assembled to deliver an Address to the Tsar (Figes, 1997, p. 173). Troops which had been posted
in the city attacked the protesters. The casualties would eventually be close to 200 deaths but
10
rumors soon circulated that thousands had felt. The “Bloody Sunday” marked a turning point
(Werth, 2004, p. 42). Spontaneous strikes became common. In the countryside movements
against the tsarist regime started to emerge. The hesitating response of the regime and the
evolution of the Russo-Japanese did nothing to arrange the situation. Indeed, the RussianJapanese war was turning to the Japanese advantage. The loss of Mukden in March 1905 was
followed by the maritime defeat at Tsushima in May 1905. The Treaty of Portsmouth signed on
September 5th, 1905 would end the war as well as the succession of Russian military defeats. In
Russia, repression against strikers and revolutionaries escalated. However the troops proved
incapable to crush the opposition and the Tsar was forced to find a compromise. On October
17th, the Tsar reluctantly signed a Manifesto granting civil liberties, constitutional order, cabinet
government and a legislative Duma elected democratically (Figes, 1997, p. 191). Eventually, these
events had forced the tsar to negotiate and to accept significant structural reforms the creation of
a parliament (the State Duma) probably being the most important (Pipes, 1990). The signature of
the Manifesto revived hope and expectations in the population which greeted the news with
enthusiasm.
The manifestations of joy would probably have been less extensive had the population
known that the Tsar’s signature had been obtained only because he could not see any alternative.
As soon as possible he would start to renege on the obligations created by the Manifesto. On the
political side, people who had joined to fight autocracy now started to express diverging views.
Constitutional Democrats (Kadets) pushed for political reforms whereas Bolsheviks were
preparing themselves for armed insurrection. The insurrection began in December, following the
arrest of Soviet leaders. Early successes for the insurgents were soon followed by a crushing
repression. Despite the success of the repression, the Douma’s opening remained on the agenda.
However to insure against the risk that parliamentarians might oppose it, the government decided
to precipitate the issue of the 1906 loan (Sack, 1927). Eventually, the loan was floated before the
11
Douma could convene its first meeting. The 5% Russian loan, intended to cover the general need
of the Treasury, saved Russia from bankruptcy. This loan was accepted on two conditions: the
constitutional reorganization of the country and the Russian support for its French Ally at the
Algeciras Conference (Girault, 1961).
Organized protest and repudiation threats
As pointed out by Long (1972), the 1906 loan is exceptional in the sense that it was the only
Russian foreign loan which led to organized protests and even to retaliatory threats and
intimidation. The success of the loan was not only a matter of emergency for the Russian
government, which was in need of funds, but a diplomatic issue for the French government. The
movements opposed to the loan were very different in origin and nature. The French Socialist
Party, the Russian Kadets as well as several Russian revolutionaries and the Société des Amis du
people russe et des peoples annexes may be mentioned (Long, 1972).
The opposition started well before the loan issue. In early 1905 already, loans to the Russian
government were already heavily criticized. The real turning point in the campaign came when
Maxim Gorky launched his appeal against the 1906 loan a few days before the loan issue. His
appeal was published in many German newspapers, in the Times but in France only in l’Humanité.
The bribes paid by the Russian government had dissuaded other French newspapers to print the
appeal (Long, 1972). On the French political side, Gorky hoped to get the support from
Clémenceau but to no avail. Representatives of the Socialist Party, such as Jean Jaurès, attacked
the loan. They stressed its immorality and the loan even became a point debated in the
framework of the 1906 elections. Anti-loan posters were placated by the Socialist candidates.
Raymond Poincaré, the French finance minister at the time, hesitated to give the green light to
this loan fearing it might be illegal (Girault, 1961). Eventually however, the loan went through.
12
During the 3rd National Conference held by the French socialist party, Ilia Roubanovitch
representing the Socialist Revolutionary, stressed that the Russian nation would not recognize the
debts which helped the Tsar crush the revolution (Parti Socialiste, 1905, p. 17). The Russian
nation would then follow the advice given by the French socialists themselves. The legality of the
loan was thus questioned from the outset. The parties at the left of the Kadets, most notably the
Social Democrats and the Socialist Revolutionaries, forewarned French investors that the loans
would be repudiated after the fall of the Tsarist regime (Long, 1972). The Socialist
Revolutionaries considered loans issued between November 10, 1905 and the convocation of the
constituent assembly illegal. Raymond Poincaré eventually agreed to the loan issue because
Russian jurists guaranteed its legality and because the Russian finance Minister, Vladimir
Kokovtsov was asking for a favour in exchange of the Russian support in Algeciras (Girault,
1961). Also, even though there was a strong opposition at the left of the Kadets party, the
Constitutional Democrat themselves were not questioning the loans legality.
In April 1906, there were thus diverging views regarding the loans legality. For the left
parties, the loan was illegal since it had been issued without the Duma’s consent. It should thus
be repudiated as soon as the Tsarist regime would have been taken care of. On the other hand,
parties at the right of the Constitutional Democrats recognized the loan’s legality and were thus
ready to fulfil the bond’s obligations. However following the dissolution of the Duma, 200
deputies, including 120 Kadets, pleaded for passive resistance to the regime. In a statement made
in Vyborg, the repudiation of the debts issued without the Duma’s consent became now
acceptable for the Kadets before being condemned in September 1906.
Debates would keep on raging regarding the 1906 loan well after its flotation and only
stopped in 1907. Regarding its legality, scholars have afterwards attempted to determine whether
13
or not the debt was odious. For some the debt issued in 1906 was used to fight against the
revolution (Renouvin, 1959)3. The fact that it did not have the consent of the Duma was also
stressed (Sack, 1927).4 Nowadays, debts are considered odious if three criteria are met i.e.: the
debt proceeds did not serve the interests of the people, the debt was not issued with the
population’s consent and investors were aware of these two elements (Khalfan, King et Thomas,
2003). Since the Duma was never consulted it is hard to prove that the population was against the
debt. However the protests organized by the various Russian parties as well as the precipitation
with which the loan was issued strongly suggest a strong opposition. Since part of the proceeds
were used to prevent further insurrections, it is also reasonable to assume that the proceeds did
not benefit the people. Eventually, in view of the protests staged against the loan, French
investors knew these elements. This suggests that the 1906 loan could be qualified as odious. In
fact, in the framework of negotiations held after the repudiation in the 1920s, the Russian
representatives would still stress the difference between pre and post 1906 loans (Delaisi, 1930, p.
10).
In February 1917, a peaceful workers' demonstration took place in St. Petersburg. Given the
little reaction from the authorities, demonstrators amplified their movement and the government
sent troops to restore order. However, those troops refused to shoot and joined the
demonstrators. Gradually the insurrection took power. Thereafter, Russia was under a double
authority: the Committee of the Duma and the Soviet of St. Petersburg. This led to the formation
of a provisional government on 15 March 1917 (Werth, 2004, pp. 88-89). The following day,
Nicolas II abdicated in favour of his brother who himself abdicated the day after (Figes, pp. 339345).
3
« en janvier 1906, un gros emprunt… pour combler le déficit considérable que la guerre de Mandchourie et les événements révolutionnaires de 1905 ont creusé dans son budget, et pour assurer, selon les termes employés par Lamsdorff, la « compression définitive du mouvement révolutionnaire ». 4 The debt was issued just before the first Duma’s meeting.
14
Since the 17 March 1917, the Provisional Government promised to respect the commitments
made by the Imperial Government (Hogenhuis-Seliverstoff, 1981, p. 16) and assume financial
obligations of the former government, including payment of interest and amortization of
sovereign debt (Sack, 1927, Freymond, 1996). On the 27 March 1917, the provisional
government issued a new loan, the “freedom loan”, wanting to show he intended to fulfil all of
its obligations. (Trotsky, 1995, p. 325)
On 7 November 1917, the Bolsheviks took power and established a "Gouvernement provisoire
ouvrier et paysan." A decree was adopted on 21 January 1918 by the Central Executive
Committee cancelling the coupons and dividends payments. All bonds issued before 25 October
1917 were cancelled.5
Russian loans maintained an excellent reputation in spite of their
repudiation for several years (Oosterlinck, 2008). While the Russian bond prices levelled off in
the late 1920s, the 1906 loan still quoted at nearly 25% of par.
During the negotiations (1918-1922), debts issued after 1905-1906 were considered illegal by the
Russians because they had been issued without the consent of the Duma (Delaisi, 1930, p. 10).
Debts issued before 1906 should be treated separately because most loans before the war were
intended economic development of Russia (Oosterlinck, 2008). Therefore, according to the legal
argument, the 1906 debt could be declared odious debt while an ‘older’ debt such as the 1822
debt would not.
IV.
Data and methodology
Two Russian sovereign debt data series are analysed in this paper: the 1906 loan and a bond
issued in 1822. Both sovereign debts were quoted in London and the goal is to disentangle the
5
The cuts below 100 rubles of the freedom loan were not cancelled. 15
odiousness effects. As seen previously, the 1906 Russian loan was not accepted by the Duma and
as we have seen above that could be declared odious. The other sovereign bond used in the
analysis is the 1822 Russian loan. The considered period starts at the first quotation of the debt in
June 1906 and stretches until June 1920 which is two years after the massive repudiation. The
monthly frequency is used and only ends of the month quotations are considered. Overall, it
represents 169 data series over a 14 years horizon.
YTM 30 25 20 15 Russia 5s of 1822 in London 10 Russia 5% Tsarist Bonds of 1906 0 30/06/1906 31/03/1907 31/12/1907 30/09/1908 30/06/1909 31/03/1910 31/12/1910 30/09/1911 30/06/1912 31/03/1913 31/12/1913 30/09/1914 30/06/1915 31/03/1916 31/12/1916 30/09/1917 30/06/1918 31/03/1919 31/12/1919 30/09/1920 5 Date Figure 1: Yield to maturity of the two Russian sovereign debts, 1906-1920
Figure 1 provide the data in yield to maturity over the all period while figure 2 gives an overview
of the data in yield to maturity before the repudiation. Obviously, once repudiated, the yield to
maturity rises dramatically. From 1911 to 1917, the difference in yield to maturity between the
two Russian sovereign debt is around 1%. The difference in basis point between the two debts is
given in figure 3. The change in difference can be attributed to several factors. The difference
represents expectations of a differentiated treatment between the 1906 and the 1822 bond. All
elements likely to affect this perception will thus impact the figures. Among others, one may
mention, the likelihood of a general repudiation (which would decrease the difference),
16
expectations about the future of the Tsarist regime (its survival leading to a lower difference) and
expectations regarding the bonds’ future. Indeed even if the 1906 bond was repudiated,
bondholders could hope for a French bailout.
YTM 8 7 6 5 4 Russia 5s of 1822 in London 3 2 Russia 5% Tsarist Bonds of 1906 0 30/06/1906 31/12/1906 30/06/1907 31/12/1907 30/06/1908 31/12/1908 30/06/1909 31/12/1909 30/06/1910 31/12/1910 30/06/1911 31/12/1911 30/06/1912 31/12/1912 30/06/1913 31/12/1913 30/06/1914 31/12/1914 30/06/1915 31/12/1915 30/06/1916 31/12/1916 30/06/1917 1 Date Figure 2: Yield to maturity of the two Russian sovereign debts, 1906-1917
160 140 120 100 80 60 difference 1906 -­‐ 1822 (bp) 40 20 0 30/06/1906 28/02/1907 31/10/1907 30/06/1908 28/02/1909 31/10/1909 30/06/1910 28/02/1911 31/10/1911 30/06/1912 28/02/1913 31/10/1913 30/06/1914 28/02/1915 31/10/1915 30/06/1916 28/02/1917 31/10/1917 30/06/1918 28/02/1919 31/10/1919 30/06/1920 bp Date Figure 3: The difference between the 1906 and 1822 debts in basis point
While the choice of the 1906 Russian loan as data is obvious given our research question, some
explanation about the second sovereign debt dataset is needed. The purpose was to find a
17
Russian sovereign debt with the same nominal value, the same coupon and relying on the same
currency.6 The Russian sovereign debt had to be issued before all hostilities and could not be
denounced as odious.7 Therefore, the chosen sovereign bond was best to be issued in the early
19th century but had to have quotations through all the period. Combining all those requirements,
the 1822 Russian Loan of 5% was a good match.
Some of the data were available on the global financial database under the name “The Russia 5%
Tsarist Bonds of 1906” and “Russia 5s of 1822 in London” respectively for the 1906 Russian
loan and the 1822 Russian loan. However, since data for the entire period was not available, 8
the missing years were entered manually from “The stock exchange daily official liste”. They were
quoted as “Russian 1906” and “Russian 1822”. Note that no “tsarist bonds” were in the
quotation name of the 1906 loan. Both sovereign debts were heavily traded and liquid. Figure 4
provides the bid-ask spread of both debts.
Spread 3.5 3 2.5 2 1.5 bid -­‐ ask spread 1906 1 bid -­‐ ask spread 1822 0 30/06/1906 28/02/1907 31/10/1907 30/06/1908 28/02/1909 31/10/1909 30/06/1910 28/02/1911 31/10/1911 30/06/1912 28/02/1913 31/10/1913 30/06/1914 28/02/1915 31/10/1915 30/06/1916 28/02/1917 31/10/1917 30/06/1918 28/02/1919 31/10/1919 30/06/1920 0.5 Date Figure 4: The bid-ask spread
6
Avoiding to focus on debts where the coupon was paid in roubles. It therefore will not meet the three criteria mentioned in the second section.
8
From 1906 until 1914 were available on-­‐line. 7
18
Since the Russian revolution began during the First World War, bond prices combines war and
repudiation effects. Therefore, this paper will also rely on data reflecting the “state of Russia” but
not repudiation of odious debts. The “state of Russia” should rely on an important number of
politics, economics, war and other variables. However, given the scarcity of data available9 on
Russia over this period, only four series of data will be part of the analysed data. Figure 5
provides an overview of the factor. According to the factor, significant shocks in Russian data
should be expected especially in 1907, 1917 and 1918.
Factor 5 4 3 2 0 -­‐1 -­‐2 30/06/1906 31/01/1907 31/08/1907 31/03/1908 31/10/1908 31/05/1909 31/12/1909 31/07/1910 28/02/1911 30/09/1911 30/04/1912 30/11/1912 30/06/1913 31/01/1914 31/08/1914 31/03/1915 31/10/1915 31/05/1916 31/12/1916 31/07/1917 28/02/1918 30/09/1918 30/04/1919 30/11/1919 30/06/1920 1 Date Figure 5: The Factor values, 1906-1920
Apart from the two bonds, four other data series have been collected over the period. First, the
“Russia Central Bank Refinancing Rate” was collected from The Economist. Secondly, the Russian
Government Printing Office provided the “Russia Consumer Price Index”. Thirdly, “Russian
government expenditure” was provided on the global financial database. Finally, the “Imperial
Bank of Russia Notes in Circulation” was found in the Investor's Monthly Manual. For all these
9
Annual data were left out because of their frequency
19
variables, the data taken refers to the end of each month except expenditure which is quarterly
data.
This paper aims to answer these questions and to disentangle the “odiousness effect”. Therefore,
the Russian bond returns are analysed using a Structural Vector Auto-Regression (SVAR)
approach (Sims, 1980; Hamilton, 1994).
The daily returns of the two bonds are computed as follows:
rt =
pt − pt −1 + Dt −1
pt −1
rt being the daily return, pt the daily bond price and Dt the dividend related to the bond.
Contrary to the bond price and yield to maturity, the daily returns are stationary according to the
standard Unit Root Test.
The factor is computed as follows:
Yi ,t = λi' ft + ui ,t
Where Yi ,t is the four data series, ft is the latent factor matrix, ui ,t is the idiosyncratic component
'
which is series-specific and λi is the factor loadings. This is done to extract the common
component factor from the four series (Geweke, 1977; Arminger and Muthen, 1998) via a
Bayesian Approach (Press, 1979 and 2003; Zellner, 1985) and the Gibbs sampling method
(Gelfand and Smith, 1990).
In order to compute the SVAR, the reduced form of the Vector Auto-Regression (VAR) is
estimated:
20
yt = A1 yt −1 + ... + Ap yt − p + α t + ε t
yt is a (3 × 1) vector of endogenous variables; the first and second elements being the monthly
return of the Russian 1822 loan and the 1906 loan, the third element being respectively the
monthly Russian factor. α t is a (3 × 1) vector of exogenous variables and ε t is the vector of
innovations which are neither correlated with its lagged values nor with yt lagged values. Finally,
A1... Ap are matrices of coefficients to be estimated. The lag j=4 has been determined through an
Akaike test on the lag selection.
As argued before, bond prices include Russian events such as the First World War. The goal is
now to separate the co-movements into two shocks associated with structural parameters. In
other words, we want to disentangle the effects of news impacted by Russia’s events from the
odious debt on the Russian debts. In practice, we set restrictions so that the orthogonal
components of the error terms are identified.
Let ut = (u1t + u2t + u3t ) ' be the orthogonal structural errors terms. The first element of ut is an
amalgam of shocks linked to Russia. The second and third elements of
are then an amalgam of
shocks that impact on the return of, respectively, the Russian 1822 loan and the Russian 1906
loan. This amalgam of shocks is set as orthogonal to the first shock.
With these specifications, a set of restrictions has been drawn, such as the orthogonormality of
the error terms ( E (ut ut ') = I ), in order to estimate the A and B matrices of the following
equation:
Aε t = But
The orthogonal structural error terms u2t and u3t then provide the orthogonal shocks.
21
V.
Results & Discussion
The impulse function is provided in figure 6. Unsurprisingly, the factor does not respond to any
Russian sovereign debt. In the same way, it turns out that the 1822 and 1906 debts are not
affected by the factor. What is more striking is that the Russian sovereign debt of 1906 does
respond with a lag to the 1822 loan. Indeed, the Russian 1906 loan responds to a lag of the 1822
debt while this is not the case the other way around. This result is robust to cholesky ordering,
however the lag and amplitude do vary a bit (see Appendix A).
Figure 6: the impulse function
The residuals and the structural VAR results of Russian 1822 debt are provided respectively in
figure 7 and 8. The structural VAR analysis is used to highlight structural shocks. No clear
structural shocks can be found in the Russian debt of 1822.
22
3 2 0 -­‐1 -­‐2 -­‐3 30/06/1906 31/01/1907 31/08/1907 31/03/1908 31/10/1908 31/05/1909 31/12/1909 31/07/1910 28/02/1911 30/09/1911 30/04/1912 30/11/1912 30/06/1913 31/01/1914 31/08/1914 31/03/1915 31/10/1915 31/05/1916 31/12/1916 31/07/1917 28/02/1918 30/09/1918 30/04/1919 30/11/1919 30/06/1920 30/06/1906 28/02/1907 31/10/1907 30/06/1908 28/02/1909 31/10/1909 30/06/1910 28/02/1911 31/10/1911 30/06/1912 28/02/1913 31/10/1913 30/06/1914 28/02/1915 31/10/1915 30/06/1916 28/02/1917 31/10/1917 30/06/1918 28/02/1919 31/10/1919 30/06/1920 0.4 0.3 0.2 0.1 Residuals 0 -­‐0.1 -­‐0.2 -­‐0.3 -­‐0.4 Dates Figure 7 : Russian 1822 Residuals
Structural shocks 1 Dates
Figure 8 : Russian 1822 structural shocks
The residuals and the structural VAR results of the Russian 1906 debt are provided respectively
in figures 9 and 10. Concerning the 1906 loan, the structural shocks are significant. The postwar
period has the most significant shocks with the exception of two negative structural shocks
occurring in 1906-1907.
23
Residuals
30/06/1906 31/01/1907 31/08/1907 31/03/1908 31/10/1908 31/05/1909 31/12/1909 31/07/1910 28/02/1911 30/09/1911 30/04/1912 30/11/1912 30/06/1913 31/01/1914 31/08/1914 31/03/1915 31/10/1915 31/05/1916 31/12/1916 31/07/1917 28/02/1918 30/09/1918 30/04/1919 30/11/1919 30/06/1920 6 5 4 3 2 1 0 -­‐1 -­‐2 -­‐3 -­‐4 -­‐5 -­‐6 Figure 9 : Russian 1906 Residuals
3 2 Structural shocks
0 -­‐1 -­‐2 -­‐3 30/06/190
31/01/190
31/08/190
31/03/190
31/10/190
31/05/190
31/12/190
31/07/191
28/02/191
30/09/191
30/04/191
30/11/191
30/06/191
31/01/191
31/08/191
31/03/191
31/10/191
31/05/191
31/12/191
31/07/191
28/02/191
30/09/191
30/04/191
30/11/191
30/06/192
1 Figure 10 : Russian 1906 structural shocks
To conclude, this paper has analyzed the Russian loans using a SVAR. So far, the Russian loans
in the 20th century have been analyzed by different authors, dealing mainly with the position of
stakeholders during the negotiations and the debts repudiation in 1918. However, the creation of
the Duma in 1906, which is a Democratic National Consultative Assembly Elected by the People,
provides a means to distinguish between odious and non-odious debts. This feature allows
therefore to achieve our objective, namely to analyze the "odiousness effect". From the impulses
functions it appears that the debt of 1906 responds with a lag to the 1822 debt. Thereafter, we
conducted a structural VAR (vector auto regression). We have found that the structural shocks of
the 1822 Russian debt were sharply reduced during the SVAR. The shocks are significant for the
1906’s loan. The largest and most significant shocks taking place after the war. However, we can
not overlook two significant shocks within the period 1906-1907.
24
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Appendix A. The impulse function changing the cholesky ordering
30