Correlations across Asia-Pacific bond markets and the impact of capital flow management measures

Abstract

Using a novel database on capital flow management measures in Asia over 2004–2013, we investigate the impact of bond inflow management measures on the cross-market correlations of weekly bond fund flows and of daily bond returns in 12 Asia-Pacific economies, after controlling for global, regional and local factors. We find that a bond inflow management measure taken by a country tends to increase the correlation of bond flows into the country with those into other countries in the region. In particular, a country’s policy actions to loosen (ie increase) bond inflows significantly increase bond flow correlations, but policy actions to tighten (ie decrease) bond inflows have no significant impact. We also find that bond inflow management measures increase bond return correlations in the long run. These results can be explained by the signalling hypothesis, under which global investors expect that when a country takes a bond inflow management measure other countries to take similar actions, so that they increase or decrease their investment in the region at the same time.