Fickle emerging market flows, stable euros, and the dollar risk factor

Abstract

Policymakers fear the destabilizing impact of fickle global investors on emerging markets. Euro area investors are significant participants in emerging bond markets and exhibit volatile flows, but their fickleness does not result in indiscriminate periods of surge and flight. Employing granular data, we discern important investor differentiation by currency denomination and issuer-level risk factors. First, euro area investors exhibit a home currency bias leading to both strong cross-sectional preference and more stable flows to EUR-denominated bonds over time. Second, volatile flows to USD and local-currency-denominated bonds are robustly related to global risk factors including the broad dollar. Investors differentiate among USD-denominated bonds such that flows to currency mismatched (and less creditworthy) sovereigns and corporates are more sensitive to the broad dollar. In contrast, local currency bond investors appear primarily concerned with currency rather than issuer-specific credit risk.