# Question

The following model was fitted to data from 28 countries in 1989 in order to explain the market value of their debt at that time:

y = secondary market price, in dollars, in 1989 of $100 of the country’s debt

x1 = 1 if U.S. bank regulators have mandated write-down for the country’s assets on books of U.S. banks, 0 otherwise

x2 = 1 if the country suspended interest payments in 1989, 2 if the country suspended interest payments before 1989 and was still in suspension, and 0 otherwise

x3 = debt-to-gross-national-product ratio

x4 = rate of real gross national product growth, 1980–1985

The numbers below the coefficients are the coefficient standard errors.

a. Interpret the estimated coefficient on x1.

b. Test the null hypothesis that, all else being equal, debt-to-gross-national-product ratio does not linearly influence the market value of a country’s debt against the alternative that the higher this ratio, the lower the value of the debt.

c. Interpret the coefficient of determination.

d. The specification of the dummy variable x2 is unorthodox. An alternative would be to replace x2 by the pair of variables (x5, x6), defined as follows:

x5 = 1 if the country suspended interest payments in 1989, 0 otherwise

x6 = 1 if the country suspended interest payments before 1989 and was still in suspension, 0 otherwise

Compare the implications of these two alternative specifications.

y = secondary market price, in dollars, in 1989 of $100 of the country’s debt

x1 = 1 if U.S. bank regulators have mandated write-down for the country’s assets on books of U.S. banks, 0 otherwise

x2 = 1 if the country suspended interest payments in 1989, 2 if the country suspended interest payments before 1989 and was still in suspension, and 0 otherwise

x3 = debt-to-gross-national-product ratio

x4 = rate of real gross national product growth, 1980–1985

The numbers below the coefficients are the coefficient standard errors.

a. Interpret the estimated coefficient on x1.

b. Test the null hypothesis that, all else being equal, debt-to-gross-national-product ratio does not linearly influence the market value of a country’s debt against the alternative that the higher this ratio, the lower the value of the debt.

c. Interpret the coefficient of determination.

d. The specification of the dummy variable x2 is unorthodox. An alternative would be to replace x2 by the pair of variables (x5, x6), defined as follows:

x5 = 1 if the country suspended interest payments in 1989, 0 otherwise

x6 = 1 if the country suspended interest payments before 1989 and was still in suspension, 0 otherwise

Compare the implications of these two alternative specifications.

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