Emerging Market Bond Research Articles

In the shadow of country risk: asset pricing model of emerging market corporate bonds

We examine the covariances of corporate bonds in emerging markets (EM) and present an asset pricing framework using instrumented principal component analysis (IPCA) that includes characteristics at the sovereign and bond levels. Our results indicate that EM bond returns are significantly influenced by country-specific risks. Incorporating these characteristics can improve both the total and cross-sectional model fit. We demonstrate that a factor framework tailored to the nuances of the EM universe generates a significant alpha of 2% per annum against the market and a higher information ratio than alternative asset pricing models, such as a conditional beta model designed for developed market (DM) bonds.

Bilateral investment treaties and sovereign default risk: Evidence for emerging markets

AbstractThis paper analyses the impact of bilateral investment treaties (BITs) on sovereign default risk using monthly data for 29 emerging markets from 1996 to 2016. Under a BIT, foreign investors can use an international arbitration scheme to enforce compensation claims against the host country's government. We focus on the so far unexplored legal risk associated with BITs since a higher likelihood of government expropriations implicitly increases public debt. We do not find a significant unconditional effect of BITs on sovereign default risk (measured by the month‐over‐month percentage change in a country's Emerging Market Bond Index). Considering the heterogeneity of BITs and political risk, we find robust and strong negative effects of BITs on sovereign bond returns. In countries with high political risk of expropriation (measured by low executive constraints), we find that the implementation of BITs with strong investor protection is associated with a significantly negative impact on sovereign bond returns (−0.45 percentage points), which compares to roughly 11.7% of bond returns' monthly standard deviation.

The causal relationship between the Emerging Markets Bond Indicator and the price performance of capital markets belonging to the Pacific Alliance

El presente artículo busca contribuir al desarrollo empírico de la relación existente entre el riesgo país, a través del Indicador de Bonos de Mercados Emergentes y el rendimiento del precio de instrumentos financieros en los mercados de capitales, para el caso de los países que integran la Alianza del Pacífico. Empleando una investigación de tipo aplicada con un enfoque cuantitativo, de diseño no experimental y de corte longitudinal, se analizaron datos diarios comprendidos en el período 2018-2022. Se utilizó la prueba de raíz unitaria de Dickey-Fuller Aumentada, prueba cointegración de Engle-Granger, modelo de vectores autorregresivos (VAR) y la prueba de causalidad de Granger. Se determinó el número de rezagos óptimos a emplear, concluyendo en causalidad bidireccional en el sentido de Granger para el caso de Chile, explicando que el Indicador de Bonos Emergentes causa al indicador bursátil de rendimiento de precio; causalidad bidireccional en el sentido de Granger para el caso de Colombia, donde ambas variables se influyen mutuamente y son predictores importantes de la otra; y causalidad unidireccional en el sentido de Granger del indicador bursátil de rendimiento de precio al riesgo país a través del Indicador de Bonos de Mercados Emergentes en el caso de México y Perú

Enhancing portfolio resilience during crisis periods: Lessons from BRICS indices and multi asset strategies

This paper uses Markowitz’s mean-variance model to construct an investment portfolio incorporating multiple assets – BRICS equity indices, Gold, crude oil, bonds, and cryptocurrencies. The optimally created risky portfolios outperform alternative portfolio optimization methods – the naive portfolio and the equal risk contribution portfolio; and established indices – the S&P 500 and the MSCI Emerging Equity Index in terms of metrics – adjusted Sharpe ratio, modified Sharpe ratio, and the modified Value at Risk. The findings are validated across different periods, including the COVID-19 period and the Russian invasion of Ukraine, including various in and out of sample periods. The findings highlight the benefits of portfolio diversity, mainly using BRICS indices, Gold, and Brent Crude oil, and challenge the notion of limited diversification benefits in BRICS indices found in previous studies. This paper further suggests the potential of emerging market bonds ETF as a diversification option during turbulent economic periods and highlights the limitations of cryptocurrencies in optimizing multi asset portfolios. By adopting the recommended multi asset portfolios, investors can enhance their risk-return trade-offs and achieve superior performance compared to the S&P500 and MSCI emerging indices. Lastly, the paper recommends future research opportunities in measuring portfolio performance and hedging strategies considering risk-adjusted return measurements, transaction expenses, and dynamic rebalancing techniques.

Practical Applications of Emerging Market Bonds: Expected Returns and Currency Impact

Practical Applications of Emerging Market Bonds: Expected Returns and Currency Impact

Exploring the performance of US international bond mutual funds

AbstractWe use a Bayesian regime switching approach to examine the performance enhancement of adding US international bond funds to a domestic bond universe pre and post the Global Financial Crisis (GFC) during January 1999 and May 2022. We find that the international bond funds provide large significant performance enhancement pre the GFC, with an increase in Certainty Equivalent Return (CER) performance of 0.595% (monthly), but none post the GFC. The performance enhancement pre GFC is driven by Large Emerging Market bond funds, which is likely fueled by a substantial drop in the Emerging Market central bank policy rates pre GFC.

Managing Liquidity of Emerging Markets Corporate Debt

Emerging market corporate bonds are perceived to offer attractive diversification potential and risk-adjusted returns, but to be illiquid. This study expands the empirical evidence by examining the liquidity of emerging market debt by solving a triangular structured system. We find emerging market bond liquidity both to share common determinants with developed markets and be influenced by macroeconomic factors. As the overall level of liquidity is lower than in developed markets, we propose a liquidity estimation model, which allows systematic factor investors to decrease the share of illiquid assets in their portfolio by roughly 3 percentage points and 10 percentage points during the COVID-19 pandemic.

How Does Inflation in Advanced Economies Affect Emerging Market Bond Yields? Empirical Evidence from Two Channels

How Does Inflation in Advanced Economies Affect Emerging Market Bond Yields? Empirical Evidence from Two Channels

Flights-to-quality from EM Bonds to safe-haven US Treasury Securities: A time-frequency Analysis

ABSTRACT We study 2001–2020 flight-to-quality episodes encompassing two planetary-scale crises: the Global Financial Crisis (GFC) of 2007–2008 and the coronavirus-triggered global meltdown. We focus on time-frequency lead-lag nexuses between holding emerging market (EM) debt and investing in relatively risk-free US Treasuries. Wavelet coherency along with the phase-difference approach is used. Our results reveal varying lead-lag patterns and low-coherence zones between EM bonds and US Treasuries, which imply the existence of appealing diversification attributes. The flights-to-quality during the crisis periods, such as the GFC and COVID-19 pandemic, emphasize the safe-haven characteristics of US Treasures. They also evidence that the post-Covid tightening of credit spreads to the pre-crisis levels is faster than the post-GFC recovery. We demonstrate that for EM debt investors, the US Treasury market allows for dynamic risk mitigation strategies during both global crises.

How do oil prices affect emerging market sovereign bond spreads?

This paper examines whether oil price changes have significant impacts on emerging market sovereign bond spreads. In particular, we focus on how different structural shocks to oil prices affect the bond spreads. Using monthly data for 15 emerging market countries from 1998 to 2019, we show evidence that shocks to oil supply play an insignificant role in determining the bond spreads. In contrast, oil-specific demand shocks have both statistically and economically significant impacts on emerging market sovereign bond spreads. Global aggregate demand shocks are of secondary importance. As oil-specific demand shocks are associated with financial market speculative activity, such activity may lead to search-for-yield behavior in emerging market bond markets, and thus reduce emerging market sovereign spreads.

Emerging Market Bonds: Expected Returns and Currency Impact

Optimizing in local currency or in currency-adjusted expected returns depends on the portfolio base currency. Currency unhedged portfolios are more suitable for EUR-based investors and much less for CHF-based portfolios. The appreciation of the portfolio base currency represents a serious risk. Emerging market bond portfolios gain from the absence of currency risk when the portfolio base currency is the US dollar. The empirical results reveal that traditional models such as mean-variance optimization (MVO), minimum-variance optimization (MinVo), and Sharpe ratio optimizations are suitable for portfolio allocation, using both local currency and currency-adjusted expected bond returns as inputs in the optimizations. However, network- and centrality-based allocations outperform traditional models.

Large international corporate bonds: Investor behavior and firm responses

Emerging market corporations have significantly increased their borrowing in international debt markets since 2008. We provide a detailed dive into this borrowing by showing that it happened in one particular market segment. Firms significantly increased their large bond issuances, mostly above US$500 million, which became cheaper to issue. We find a strong clustering of issuances with a face value of exactly $500 million after 2008 compared to developed markets. This suggests increased willingness from investors, especially cross-over investors, to purchase emerging market bonds included in newly created bond indexes, which require a minimum face value of $500 million. However, not all firms could issue such large bonds. Firms large enough to do so faced a trade-off. Issuing index-eligible bonds allowed them to borrow at a lower cost at the expense of accumulating cash. Because of this “size yield discount,” many companies increased their issuances of index-eligible bonds, accumulating cash holdings.

Practical Applications of What Portfolio in Europe Makes Sense?

In <b><i>What Portfolio in Europe Makes Sense?</i></b> from the July 2021 special issue on non-US financial markets of <b><i>The Journal of Portfolio Management</i></b>, author <b>Gueorgui Konstantinov</b> (of <b>LBBW Asset and Wealth Management</b>) analyzes European stock and bond performance. Investors have generally preferred European bonds, which have outperformed European stocks. However, eurozone economic development and demand for low-risk investments has recently driven bond yields down into negative territory. This, combined with poor long-term European stock performance, casts doubt on whether a balanced European portfolio with a large allocation to bonds can provide attractive returns. The author analyzes long- and short-term European stock and bond returns and calculates the past performance of a model set of balanced portfolios. He finds that the popular European 40/60 stock/bond balanced portfolio is unlikely to provide desirable future returns because European bonds, not stocks, are now the riskier investment. This is due to the bonds’ negative yields and high volatility, plus rising inflation. However, European emerging-market bonds have the best risk–return profile, and European stock returns are improving. The author says balanced-fund managers may wish to add emerging-market bonds and derivatives to portfolios, while investors may wish to switch to a 60/40 stock/bond allocation.

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.

Inferences from Portfolio Theory and Efficient Market Hypothesis to the Impact of Social Media on Sovereign Debt: Colombia, Ecuador, and Peru

For three countries of similar economic characteristics, I ratify previous studies of the impact of fundamental macroeconomic and foreign exchange variables influencing country risk, as captured by the Emerging Market Bond Index (EMBI). I contribute to existing research, first by calculating a proxy of risk I call endogenous risk that analyzes the quarterly variability of economic activity, and second, by calculating a variable of sentiment from Twitter activity. I gauge the impact of both on the country risk metric in addition to variables in existing research about the determinants of country risk. Foreign exchange variables are the most significant determinants of risk for the countries of Colombia and Peru, which actively manage their currency, while Ecuador’s country risk is mostly affected by endogenous risk and macroeconomic fundamentals.

Volatility Spillover Across Sovereign Bond Markets Between African, Emerging and USA Economies

Abstract This study attempted to examine the volatility spillover between the sovereign bond returns of South Africa and Ghana and the emerging market bond return, USA stock market return and the world long term interest rate using weekly data in the period of 2014–2022. The research used dynamic and constant conditional correlation generalized auto-regressive conditional Heteroskedasticsticity models. The result showed that the volatility of long-term world bond interest rate and USA stock market return affected the Ghana sovereign bond return positively and negatively, respectively. Similarly, the volatility of emerging market bond return and long-term world interest rate affected the South African sovereign bond return positively and negatively, respectively. Thus, policy intervention is needed to contain the negative impact of stock market and long-term world interest rates.

Emerging Market Bond Flows and Exchange Rate Returns

Emerging Market Bond Flows and Exchange Rate Returns

Risk-dependent centrality in the Brazilian stock market

Abstract The purpose of this article is to calculate the risk-dependent centrality (RDC) assessing the Brazilian stock market. We computed the RDC for assets traded on the Brazilian stock market between January 2008 and June 2020 at different levels of external risk. We observed that the ranking of assets based on the RDC depends on the external risk. Rankings’ volatility is related to crisis events, capturing the recent Brazilian economic-political crisis. Moreover, we computed the RDC employing an empirically computed external risk level, relying on the Emerging Markets Bond Index index. We show that some economic sectors (oil, gas and biofuels and financial) become more central during crisis periods. Moreover, the volatility of the RDC is positively correlated with the external risk level.

Drivers of Emerging Market Bond Flows and Prices

Drivers of Emerging Market Bond Flows and Prices

The Argument for Bonds in Strategic Asset Allocation

A number of well-known practitioners such as Warren Buffett and Jeremy Siegel have long advocated a strategic asset allocation in which investors hold a majority of their assets in equities. However, in this simple straightforward study of investable indices, the authors find that in order to maximize the well-known Sharpe ratio, most investors over the period 1995–2019 would have been better off holding a majority of their assets in bond indices rather than stock indices. While interest rates have decreased during this 25-year period and thus enhanced bond relative returns, their results are quite convincing. Even though the results are obviously ex post, investors very often make decisions on future investment based on past performance and thus our results could provide guidance to investors for future investing decisions. <b>Key Findings</b> ▪ In order to maximize the Sharpe ratio, most investors over the 1995–2019 period would have been better off holding a majority of their assets in bond indices rather than stock indices. ▪ For a portfolio at the 4% annualized standard deviation level, the percentage that should have been held in a US aggregate bond index over the time period studied is 79%, on average. As the risk level increases, the percentage held in the US bond index decreases substantially in favor of investing in an emerging market bond index. For a portfolio at the 10% annualized standard deviation level, the percentage that should have been held in an emerging market bond index is approximately 63%, on average. ▪ Bond indices, whether they be domestic or emerging markets indices, should have been a much larger proportion of one’s portfolio than is often stated by finance professionals and commentators.