Bond and Stock Market Linkages: The Case of Mexico and Brazil

Abstract

Research on emerging market bonds has been growing quickly (see, for example, Min, 1998).1 This can be attributed to two main factors. First, while emerging market bond capitalization is relatively small compared to the size of the fixed-income market, it has still attracted the attention of investors. There have been times (for example, in the summer of 1997) when the average performance of the Emerging Market Bond Index is better than that of the S&P 500, and is considerably better than the US high-yield index. Among the debt instruments in the emerging markets, Brady bonds are the most important. Overall, there are about US $200bn of Brady bonds outstanding. According to the Emerging Market Traders Association, the secondary market turnover for Brady bonds represents the majority of all trading in emerging market debt instruments. Second, the sovereign bond yield spreads over the yield of similar issues from the US Treasury has become a market-based measure of sovereign credit worthiness. It has been argued that the credit worthiness of economies as measured by agencies such as Institutional Investor, Moody s and Standard and Poor’s are only ex post indicators and may not be useful measures for those who are more interested in the future performance of an economy. As a result, recent literature on sovereign credit worthiness has focused on market-determined indicators, such as the Brady bond stripped yield spread, as the purest form of market-based sovereign risk.