Emerging Market Bond Spreads Research Articles

The differential impact of political risk factors on emerging market bond spreads and credit rating outlooks

It is well established that sovereign bond spreads vary with changes in financial conditions and political risk factors. What is less evident is the differential impact of political risk factors relative to the financial conditions of emerging market (EM) countries. This paper fills this gap by analyzing how changes in political risk overall and political risk components impact EM bond spreads and credit ratings. We find that improving political risk factors lowers sovereign bond spreads and improves credit rating outlooks. However, the effect varies by type of political risk. Also, the impact varies by type of EM country, with more of the impact of political risk components affecting higher financial risk countries.

The Impact of the Global Financial Safety Net on Emerging Market Bond Spreads

Following the 2007–2008 global financial crisis, it became evident that there was a need for a strengthening of the global financial safety net (GFSN). The manner in which this should be achieved became a polarising issue of debate in international institutions such as the International Monetary Fund and the G20. Empirical evidence concerning the impact of the GFSN remains scarce. Therefore, this paper seeks to contribute to the debate by investigating the potential impacts that the various layers of the GFSN can have on sovereign borrowing costs in emerging markets. This analysis first reviews the common methodologies that can be found in the literature concerned with identifying determinants of foreign currency sovereign spreads in emerging markets. The analysis is then expanded to include elements of the GFSN. The results indicate that whilst the liquidity buffers provided by the overall GFSN appear to lower sovereign spreads, the impact of individual layers of the safety net is more ambiguous.

Emerging market bond spreads: The role of global and domestic factors from 2002 to 2011

We address the importance of external versus domestic conditions in determining emerging market bond (EMBI) spreads. Using principal components, we derive a measure of global risk aversion, which is shown to have a significant and, when interacted with a country's foreign debt to GNI ratio, nonlinear effect on these bond spreads. Our model, estimated using Pooled Mean Group techniques, which also incorporates country-specific variables (foreign debt, fiscal policy, debt servicing and political risk), is able to track developments in emerging market bond spreads over the period May 2002 to October 2011 quite well. From mid 2002 to mid 2007, the model suggests that just over two thirds of the decline in these spreads on average reflected improved fundamentals, with the rest due to easy credit conditions. During the 2008 crisis, virtually all of the run-up in emerging market spreads was due to the large increase in our measure of risk aversion. A model of the measure of risk aversion is also estimated, which identifies as its key drivers, the outlook for growth in the major OECD and large non-OECD economies as well as US credit supply conditions.

U.S. Interest Rates and Emerging Market BondYield Spreads:A Changing Relationship?

The empirical evidence on the impact of international interest rates on emerging market (EM) bond spreads is mixed. In this article, we closely examine the 2000–2009 period and find a negative relationship between U.S. interest rates and EM bond spreads. We argue that the relationship between U.S. short rates and EM bond spreads is unstable and can change depending on how other “push” and “pull” factors, such as investors’ appetite for risk and emerging markets’ economic fundamentals, interact.

Global Factors and Emerging Market Spreads*

This paper shows that a large fraction of the variability of emerging market bond spreads is explained by the evolution of global factors such as risk appetite (as reflected in the spread of high yield corporate bonds in developed markets), global liquidity (measured by the international interest rates) and contagion (from systemic events like the Russian default). This link has remained relatively stable over the history of the emerging market class, is robust to the inclusion of country-specific factors, and helps provide accurate long-run predictions. Overall, the results highlight the critical role played by exogenous factors in the evolution of the borrowing cost faced by emerging economies.

Global monetary conditions versus country-specific factors in the determination of emerging market debt spreads

US interest rate policy is shown to have a significant influence on emerging market bond spreads, but it is important to allow for non-linearities: US interest rates affect secondary market spreads differently, depending on countries' debt levels. Moderate debtors suffer little impact from an increase in US interest rates, while a country close to the borderline of solvency would face a much steeper increase in its spread. A 200 basis points increase in US short-term interest rates would increase emerging market spreads by 6–65 bps, depending on debt/GNI ratios.

Sound Policies or Good Fortune: What Drives Emerging Market Spreads?

Since 2002, spreads on emerging market sovereign debt have fallen to historical lows. Given the close links between sovereign spreads, capital flows to emerging markets, and economic growth, understanding the factors driving sovereign spreads is very important. This paper uses factor analysis to study the extent to which emerging market bond spreads ‐ measured by JP Morgan’s EMBI Global index ‐ are driven by global factors, such as global liquidity or commodity prices, as opposed to country-specific macroeconomic fundamentals. Our results show that a common factor explains a substantial portion of the co-movements in emerging market spreads in the last decade. This factor is closely linked to global financial conditions, as well as to energy- and non-energy commodity prices. This factor, however, is not responsible for the reduction in EMBI spreads. Instead, emerging markets have benefited considerably from better macroeconomic policies. Therefore, a reversal of the benign global economic environment need not have a substantial negative impact on financing conditions for emerging markets. Bank index: Development economics, financial stability, international topics

Do Country Fundamentals Explain Emerging Market Bond Spreads?

This paper shows that emerging market eurobond spreads after the Asian crisis can be almost completely explained by market expectations about macroeconomic fundamentals and international interest rates. Contrary to the claim that emerging market bond spreads are driven by market variables such as stock market volatility in the developed countries, it is found that this did not play a significant role after the Asian crisis. Using panel data techniques, it is shown that the determinants of bond spreads can be divided into long-term structural variables and medium-term variables which explain month-to-month changes in bond spreads. As relevant medium-term variables, ''consensus forecasts'' of real GDP growth and inflation, and international interest rates are identified. The long-term structural factors do not explicitly enter the model and show up as fixed or random country-specific effects. These intercepts are highly correlated with the countries' credit rating.

The Returns to Developed-Market Acquirers in Emerging Markets

In stark contrast to the findings based on domestic M&A transactions, we find that the developed-market acquirers experience positive and significant announcement returns in transactions that involve an emerging-market target. On average, over the 1988-2003 period, developed-market acquirer returns show a statistically significant increase of 1.18% over a three-week event window when M&A transactions in emerging markets are announced. Abnormal returns for target firms are also positive and on average equal 6.8%. The acquisition of majority control is a key feature of transactions that deliver positive acquirer returns - acquirer return increases range from 3.3% to 4.9% when majority control of an emerging-market target is acquired. The results are robust to the inclusion of controls for country, time, industrial diversification, method of payment effects, as well as acquirer- and target-firm characteristics such as size and liquidity. We find positive support for two hypotheses which can explain these unique findings. First, we find that developed-market acquirer returns increase as emerging-market bond spreads widen. This suggests the ability of developed-market acquirers to provide access to finance may be particularly valuable for targets located in capital-scarce emerging markets. Second, we find that developed-market acquirer returns increase significantly when they gain majority control of targets in countries with high risks of expropriation and contract repudiation and a weak rule of law. We find minority control acquisitions in these same countries do not produce the same results. We argue that in majority control acquisitions the boundaries of the firm are extended, thus bonding an emerging-market target firm to a developed-market acquirer from a country with better institutions.

Does corruption increase emerging market bond spreads?

We study the relationship between corruption and borrowing costs for governments and firms in emerging markets. Combining data on bonds traded in the global market with survey data on corruption compiled by Transparency International, we show that countries that are perceived as more corrupt must pay a higher risk premium when issuing bonds. The global bond market ascribes a significant cost to corruption: an improvement in the corruption score from the level of Lithuania to that of the Czech Republic lowers the bond spread by about one-fifth. This is true even after controlling for macroeconomic effects that are correlated with corruption. We find little evidence that investors became more sensitive to corruption in the wake of the Asian financial crisis.

The Normal, the Fat-Tailed, and the Contagious: Modeling Changes in Emerging Market Bond Spreads

We examine the statistical properties of daily changes in emerging market bond spreads over US treasuries, and simulate an agent-based model to attempt to replicate those properties. The actual data indicate that changes in spreads: 1) are definitely not normally distributed, exhibiting much fatter tails; 2) are serially correlated, suggesting deviation from market efficiency; and 3) exhibit excessive co-movement, suggesting contagion. A simple model of interacting traders produces alternating booms and crashes, as in reality, but is not capable of producing fat-tailed distributions or contagion. We focus on an extended model with market makers whose bid/asked spreads widen with increased volatility and the size of their inventory. This model highlights the role of liquidity (or lack of it) in explaining large rate movements and contagion.

Emerging market bond spreads and sovereign credit ratings: reconciling market views with economic fundamentals

This paper uses a panel data estimation of a simple univariate model of sovereign spreads on ratings to analyze statistically significant differences between actual spreads and ratings-based spreads. When such deviations are significant, we find that ‘excessively high’ spreads are on average followed by episodes of spread tightening 1 month later rather than credit downgrades. In contrast, observations with ‘excessively low’ spreads are on average followed by rating upgrades 3 months later rather than episodes of spread widening. The paper also illustrates how significant disagreements between market and rating agencies’ views can be used as a signal that further technical and sovereign analysis is warranted. For instance, we find that spreads were ‘excessively low’ for most emerging markets before the Asian crisis. More recently, spreads were ‘excessively high’ for a number of emerging markets.

Does Corruption Increase Emerging Market Bond Spreads?

We study the relationship between corruption and borrowing costs for governments and firms in emerging markets. Combining data on bonds traded in the global market with survey data on corruption compiled by Transparency International, we show that countries that are perceived as more corrupt may pay a higher risk premium when issuing bonds. The global bond market ascribes a significant cost to corruption: an improvement in the corruption score from the level of Lithuania to that of the Czech Republic lowers the bond spread by about one-fifth. This is true even after controlling for macroeconomic effects that are correlated with corruption. We find little evidence that investors became more sensitive to corruption in the wake of the Asian financial crisis.

Monetary Independence in Emerging Markets: Does the Exchange Rate Regime Make a Difference?

This paper compares the impact of shocks to U.S. interest rates and emerging market bond spreads on domestic interest rates and exchange rates across several emerging market economies with different exchange rate regimes. Consistent with conventional priors, the results indicate that interest rates in Hong Kong react much more to U.S. interest rate shocks and shocks to international risk premia than interest rates in Singapore. The results are less clearcut in the comparison of Argentina and Mexico: while interest rates (and the exchange rate) in Mexico seem to react less to U.S. interest rate shocks, they react about the same to bond spread shocks, in addition to a significant impact on the exchange rate.

Monetary Independence in Emerging Markets: Does the Exchange Rate Regime Make a Difference?

This paper compares the impact of shocks to U.S. interest rates and emerging market bond spreads on domestic interest rates and exchange rates across several emerging market economies with different exchange rate regimes. Consistent with conventional priors, the results indicate that interest rates in Hong Kong react much more to U.S. interest rate shocks and shocks to international risk premia than interest rates in Singapore. The results are less clearcut in the comparison of Argentina and Mexico: While interest rates (and the exchange rate) in Mexico seem to react less to U.S. interest rate shocks, they react about the same to bond spread shocks, in addition to a significant impact on the exchange rate.

Emerging Market Bond Spreads and Sovereign Credit Ratings: Reconciling Market Views with Economic Fundamentals

This paper uses a panel data estimation of a simple univariate model of sovereign spreads on ratings to analyze statistically significant deviations from the estimated relationship. We find evidence of an asymmetric adjustment of spreads and ratings when such deviations are significant. In addition, the paper illustrates how significant disagreements between market and rating agencies' views can be used as a signal that further technical and sovereign analysis is warranted. For instance, we find that spreads were excessively low for most emerging markets before the Asian crisis. More recently, spreads were excessively high for a number of emerging markets.

Emerging Market Bond Spreads and Sovereign Credit Ratings:Reconciling Market Views with Economic Fundamentals

This paper uses a panel data estimation of a simple univariate model of sovereign spreads on ratings to analyze statistically significant deviations from the estimated relationship. We find evidence of an asymmetric adjustment of spreads and ratings when such deviations are significant. In addition, the paper illustrates how significant disagreements between market and rating agencies' views can be used as a signal that further technical and sovereign analysis is warranted. For instance, we find that spreads were excessively low for most emerging markets before the Asian crisis. More recently, spreads were excessively high for a number of emerging markets.

Emerging Market Bond Spreads and Sovereign Credit Ratings: Reconciling Market Views with Economic Fundamentals

This paper uses a panel data estimation of a simple univariate model of sovereign spreads on ratings to analyze statistically significant deviations from the estimated relationship. We find evidence of an asymmetric adjustment of spreads and ratings when such deviations are significant. In addition, the paper illustrates how significant disagreements between market and rating agencies' views can be used as a signal that further technical and sovereign analysis is warranted. For instance, we find that spreads were excessively low for most emerging markets before the Asian crisis. More recently, spreads were excessively high for a number of emerging markets.

The Evolution and Determinants of Emerging Market Credit Spreads in the 1990s

This paper develops measures of emerging market credit spreads for the 1990s, based on data on new bond issues and bank loans, that cover a broader range of borrowers than the Brady bond spreads most commonly used to date. These measures are used to identify the impacts of credit ratings, maturity and currency denomination on spreads. We find important regional differences in spreads across the developing world, even after controlling for risk and maturity. We also identify the evolution of spreads during the 1990s up until the advent of the Asian financial crisis, holding other determinants constant, and find that emerging market spreads declined by more than can be explained by improvements in risk. However, for emerging market instruments with relatively favourable credit ratings, trends in spreads differed considerably from those experienced by Brady bonds. Finally, and in contrast to much market commentary, we find that variations in industrial country short-term interest rates explain relatively little of the decline in emerging market bond spreads. Longer-term trends, perhaps reflecting globalisation, along with the temporary impact of the Mexican financial crisis, may have been more important factors in the behaviour of emerging market spreads.

The Evolution and Determinants of Emerging Market Credit Spreads in the 1990s

This paper develops measures of emerging market credit spreads for the 1990s, based on data on new bond issues and bank loans, that cover a broader range of borrowers than the Brady bond spreads most commonly used to date. These measures are used to identify the impacts of credit ratings, maturity and currency denomination on spreads. We find important regional differences in spreads across the developing world, even after controlling for risk and maturity. We also identify the evolution of spreads during the 1990s up until the advent of the Asian financial crisis, holding other determinants constant, and find that emerging market spreads declined by more than can be explained by improvements in risk. However, for emerging market instruments with relatively favourable credit ratings, trends in spreads differed considerably from those experienced by Brady bonds. Finally, and in contrast to much market commentary, we find that variations in industrial country short-term interest rates explain relatively little of the decline in emerging market bond spreads. Longer-term trends, perhaps reflecting globalisation, along with the temporary impact of the Mexican financial crisis, may have been more important factors in the behaviour of emerging market spreads.