Emerging Market Bond Research Articles

Style Analysis and Value at Risk of Asia-Focused Hedge Funds

In this paper, we attempt to identify risk factors for Asia-focused hedge funds through modified style analysis technique. Using an Asian hedge fund index, we find that Asian hedge funds show significant positive exposures to emerging equity markets, especially emerging markets in Asia, and also hold significant portion of portfolio in cash and high credit rating bonds while short sell world government bond and emerging market bonds. A rolling window style analysis is further employed to analyse the time-variation risk exposures of Asian hedge funds. For both static and rolling period style analysis, our model provides a high explanatory power for returns of the hedge fund index. We further conduct a Value-at-Risk analysis using the results of rolling window style analysis as inputs. Our results indicate that the accuracy of VaR model is dominated by its ability to capture the tail distribution of the hedge fund returns. Moreover, the distribution assumption is superior to the volatility model in VaR forecast. Also, our findings suggest that parametric approach outperforms the historical simulation based past observation.

Correlations in emerging market bonds: The role of local and global factors

This paper empirically assesses co-movements in emerging market bond returns and disentangles the roles of external and domestic factors during episodes of heightened market volatility. The conceptual framework, set in the context of asset allocation, allows us to describe the channels through which shocks originating in a particular emerging or mature market are transmitted across countries and markets. We show that a simple measure of cross-country correlations, when presented together with the more commonly used average correlation coefficient, can be more informative during episodes of heightened market volatility. Data for the period 1997–2008 are analysed for evidence of true contagion and common external shocks.

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.

Nonlinear behaviour of emerging market bonds spreads: the Latin American case

In this article we check for nonlinear behaviour of the 10 most important Latin American emerging market bonds spreads. Applying the Hinich portmanteau bicorrelation test, the BDS test and the Engle LM test, we observe systematic nonlinear structure in the spreads series. Our results suggest that the nonlinear serial dependencies are episodic in nature. All the stock returns series (with the exception of Mexico) are characterized by few brief periods of highly significant nonlinearity, followed by long time periods in which the returns follow a pure noise process. Our findings support the idea that, even in this well informed and sophisticated market, the weak-form of the efficient market hypothesis cannot be supported.

Empirical Evidence on CDO Performance

Despite the recent infamy of collateralized debt obligations (CDOs), there is a dearth of literature quantifying the performance of this fixed-income product. While performance is usually measured in terms of return relative to a benchmark, lack of pricing information necessitates an alternative methodology for assessing CDO performance. In this article, we use rating changes (principally downgrades) to assess 10 types of CDOs across 11 vintages, analyzing 4,328 CDOs and 13,333 tranches in total. We find the following: Asset-backed CDOs have performed far worse than other CDOs issued 1999–2007. Market value CDOs are the second-worse performers. Collateralized loan obligations (CLOs) and CDOs backed by emerging market bonds, investment-grade bonds, and high-yield bonds have significantly outperformed other types of CDOs over the last four years of issuance.

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.

A Cheap Lunch for Emerging Markets: Removing International Financial Market Imperfections with Modern Financial Instruments

Summary This paper develops a market-based procedure to significantly reduce the indebtedness of emerging markets by applying an asset-backed security approach to a pool of emerging market bonds. In an extensive simulation study based on historical data, the cumulated interest savings over a horizon of 10 years amount to about 20% of the credit sum on average (with a standard deviation of 8%) and up to 44% for individual countries—dependent on the internal distribution of the surplus. The theoretical structure of the transaction is explicitly derived in cooperation with professionals from major commercial banks, and it implies only negligible implementation cost. The implementation requires neither institutional reforms nor debt forgiveness, but can supplement or substitute previous measures.

Fear of Declaring: Do Markets Care What Countries Say About Their Exchange Rate Policies?

Beginning with the papers by Calvo and Reinhart (2002) and Levy Yeyati and Sturzenegger (2001), there has been growing recognition of a disconnect between what emerging economies say they do in exchange rate policy (words), and what they do in practice (deeds). More specifically, a “fear of floating” behavior has been identified, whereby countries that classify themselves as floating exchange rate regimes intervene quite vigorously over time. While many persuasive arguments have been offered as to why countries intervene, the question remains as to why intervening countries continue to classify their regimes as floating. Thus, concurrently with fear of floating, there seems to be a “fear of declaring.” This paper examines one possible reason for fear of declaring: that international capital markets might reward countries that are classified toward the flexible end of the spectrum. Based on the JPMorgan Emerging Market Bond Index spread, we use a panel data approach that exploits both time and cross-country variability. With some qualifications, we find that spreads are lower in countries that have a fixed exchange rate regime, whether de jure or de facto, implying that there is no evidence that markets punish fear of floating. One possible explanation for this puzzle—that is, countries intervene but say that they do not, even though markets appear to be, at a minimum, indifferent to intervention—arises from the fact that there is evidence that de jure floating regimes may fare better in crisis situations.

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

Emerging Market Bond Funds: A Comprehensive Analysis

AbstractWe analyze U.S.‐based emerging market bond funds over a ten‐year (1996–2005) complete cycle of ups and downs in the dominant emerging bond markets. Emerging market bond funds outperform comparable domestic and global bond funds. The results are robust across both conditional and unconditional models. The funds also provide international diversification benefits to U.S. and international bond and equity portfolios. The funds exhibit persistence in performance and seasonality. Active funds, large funds and funds with high minimum purchases perform better on a total return basis but not on a risk‐adjusted basis.

Standard & Poor's Indices Versus Active Funds Scorecard, Mid Year 2008

The S&P Indices Versus Active Funds (SPIVA) Scorecard report performance comparisons corrected for survivorship bias, shows equal- and asset-weighted peer averages, and provides measures of style consistency covering actively managed U.S. equity, international equity and fixed income mutual funds. Starting with this report, we reintroduce an enhanced SPIVA with broader asset class coverage. Data for enhanced SPIVA is from the CRSP Survivor-Bias-Free U.S. Mutual Fund Database. To accommodate CRSP release schedules, the new SPIVA will be published semi-annually with a fourteen week lag. Over five years ending June 2008, S&P 500 outperformed 68.6% of actively managed large cap funds, S&P MidCap 400 outperformed 75.9% of mid cap funds and S&P SmallCap 600 outperformed 77.8% of small cap funds. Among global equity funds, five-year results show S&P Global 1200 outperforming 70.1% of global equity funds, S&P 700 outperforming 86.5% of international equity funds, and S&P IFCI Composite outperforming 73.9% of emerging market funds. Among fixed income funds, indices outperformed twelve of thirteen categories over a five-year horizon. Only emerging market bond funds outperformed their benchmark index. Funds disappear at a meaningful rate. Over five years, 26.8% of U.S. equity funds, 22.5% of global equity funds and 24.7% of fixed income funds have been merged or liquidated. This highlights the importance of addressing survivorship bias in mutual fund analysis.

Emerging Market Bonds as an Asset Class

Emerging market bonds improve the efficient frontier of a mixed-asset portfolio. The improvement is based on the application of mean-variance spanning tests on returns that are free from survivorship bias. The results indicate that emerging market bonds span a portfolio comprised of U.S. stocks, U.S. bonds, international equity, and international bonds from developed markets. Mean-variance optimizations suggest that a typical fund sponsor might consider overweighting its allocation towards emerging market bonds. <b>TOPICS:</b>Emerging markets, fixed income portfolio management, portfolio construction

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.

What do bond holdings reveal about international funds' preferences?

International bond funds are important institutional investors in emerging markets and their asset allocation decisions have significant implications for bond market developments and debt management policies in developing countries. This paper studies emerging market bond holdings of international funds and analyzes economic and financial factors affecting their bond preferences. It shows that mutual funds prefer to invest in countries with sound fundamentals and more openness to trade. In addition, they favor bonds with high past returns and yields while averting bonds with high transaction costs and idiosyncratic risks.

The impact of macroeconomic announcements on emerging market bonds

This paper examines how emerging market bonds react to macroeconomic announcements. Global bond spreads respond to rating actions and changes in U.S. interest rates rather than domestic data and policy announcements. All announcements affect market volatility. Macroeconomic data and policy announcements reduce uncertainty and stabilize spreads, while rating actions cause greater volatility. Results are robust to country-specific and panel analyses, assuming conditional variance and controlling for the surprise content of news. In subsamples, announcements matter less for countries with more transparent policies and higher credit ratings. In a crisis, rating actions become less important, and investors focus on simple and timely indicators.

Volatility and Jump Risk Premia in Emerging Market Bonds

There is strong evidence that interest rates and bond yield movements exhibit both stochastic volatility and unanticipated jumps. The presence of frequent jumps makes it natural to ask whether there is a premium for jump risk embedded in observed bond yields. This paper identifies a class of jump-diffusion models that are successful in approximating the term structure of interest rates of emerging markets. The parameters of the term structure of interest rates are reconciled with the associated bond yields by estimating the volatility and jump risk premia in highly volatile markets. Using the simulated method of moments (SMM), results suggest that all variants of models which do not take into account stochastic volatility and unanticipated jumps cannot generate the non-normalities consistent with the observed interest rates. Jumps occur (8,10) times a year in Argentina and Brazil, respectively. The size and variance of these jumps is also of statistical significance.

Volatility and Jump Risk Premia in Emerging Market Bonds

Volatility and Jump Risk Premia in Emerging Market Bonds

Financial Linkages Between the U.S. and Latin Amercia: Evidence From Daily Data

Motivated by recent bursts of global financial market turbulence, this paper investigates the linkages between the financial markets in the United States and those of the seven largest Latin American economies, focusing on the impact of shocks originating in the U.S. stock, bond, and currency markets. After documenting that cross-country linkages were different in tranquil and turbulent times within our sample, we find that: (i) for stock markets, recent episodes of market turbulence stood out from preceding ones as they showed an increased sensitivity of Latin American markets to U.S. shocks, reversing a trend of weakening linkages; (ii) currency markets in Latin America exhibited a decrease in cross-market linkages with the U.S. during the last episodes of volatility, consistent with increased exchange rate flexibility in the region; and (iii) the external bond markets in Latin America remained on a trend of weakening linkages with U.S. corporate bonds, while they increased their sensitivity to movements in other emerging market bond markets.

Hedging emerging market bonds and the rise of the credit default swap

On October 5, 2001, when credit spreads were widening, the Chicago Mercantile Exchange CME de-listed the full menu of emerging market Brady bond futures contracts. This is intriguing because at a time when interest in hedging and speculating in emerging market sovereign credit risk should be at its peak, the CME de-listed precisely the sort of contract designed to hedge and speculate in sovereign credit risk. This paper finds statistical evidence suggesting that the developing over the counter CDS contract acted as a substitute product for the Brady bond futures contract thereby undermining the Brady bond futures contract and contributing to its demise.

A Free Lunch for Emerging Markets: Removing International Financial Market Imperfections with Modern Finance Instruments

Regulations and frictions of the market for emerging market bonds keep up the price of capital demanded by emerging countries. Instruments of modern finance, i.e. a pool of emerging market bonds refinanced via an enhanced Asset Backed Securities structure, can significantly reduce the interest payments. In an extensive simulation study based on empirical data, the cumulated interest savings for a horizon of 10 years amount to up to 44% of the credit sum. The theoretical structure of the transaction is explicitly derived in cooperation with professionals from major commercial banks and thus realistic. The implementation is costless and does neither require institutional reforms nor debt forgiveness and is in line with market forces.