Foreign Bonds Research Articles

A Fiscal Theory of the Currency Risk Premium and of Sterilized Intervention

This paper develops a dynamic stochastic general equilibrium monetary portfolio choice model that accomplishes two objectives. First, it provides a theory of currency risk premia based on a weak and plausible form of fiscal nonneutrality. Domestic and foreign bonds become imperfect substitutes, the uncovered interest parity condition is replaced with a portfolio balance equation, and the central bank can separately choose the growth rate of its nominal anchor and the domestic bond interest rate. Second, it can turn be shown that, and how, sterilized intervention affects equilibrium allocations and prices.

A Fiscal Theory of the Currency Risk Premium and of Sterilized Intervention

This paper develops a dynamic stochastic general equilibrium monetary portfolio choice model that accomplishes two objectives. First, it provides a theory of currency risk premia based on a weak and plausible form of fiscal nonneutrality. Domestic and foreign bonds become imperfect substitutes, the uncovered interest parity condition is replaced with a portfolio balance equation, and the central bank can separately choose the growth rate of its nominal anchor and the domestic bond interest rate. Second, it can turn be shown that, and how, sterilized intervention affects equilibrium allocations and prices.

Financial Centers and the Geography of Capital Flows

We examine an assumption common in empirical work on bilateral portfolio capital flows that the countries the flows are attributed to are also the countries of the securityâ s issuer, seller, or ultimate buyer. We do this by estimating U.S. investorsâ holdings of debt and equities in over 40 countries and, for the same countries, foreign investorsâ holdings of U.S. debt and equities. A comparison of our estimates with data from benchmark surveys provides insight into U.S. data on international debt and equity transactions. We find that, contrary to the common assumption, the data do not track the location of U.S. investment or the location of investors in U.S. assets very well. Because the U.S. portfolio flow data collection system was designed to measure cross-border transactions with foreign counterparties who are often intermediaries, the majority of the flows are attributed to financial centers. By aggregating our country-level estimates, we find that U.S. data accurately portray net inflows into U.S. equities and net outflows into foreign bonds. However, the data substantially overcount net inflows into U.S. bonds and may undercount net outflows into foreign equities. We conclude with a discussion of the implications of our findings for research on capital flows.

Exoploring the benefits of international diversification and currency hedging for international fund portfolios

Outlines previous research on international investment portfolios and presents a study of diversification and hedging on money market, bond and equity funds from UK, US and Japanese investors’ points of view. Explains the methodology, uses 1995‐1998 data to calculate returns and discusses the results. Suggests that foreign bonds and equities reduce exchange rate risk more effectively than money market instruments, although some of that risk is not diversifiable. Compares the benefits of diversification and hedging for investors in the three countries at different levels of risk and concludes that optimum asset allocation depends on the fund market characteristics, risk preferences and investor perspective.

The performance persistence of foreign closed‐end funds

AbstractA sample of 26 foreign bond and 95 foreign equity closed‐end funds is used to determine whether foreign closed‐end funds exhibit performance persistence (PP). Persistence is measured using two different performance measures, net asset value (NAV) returns and market price (MP) returns. The results show that foreign closed‐end equity funds exhibit persistence of MP performance. These results are generally robust with respect to the holding period. In general, the PP results are mainly attributed to winning funds. A comparison of foreign to domestic closed‐end funds finds that foreign closed‐end equity funds exhibit less PP than domestic equity funds.

A Valuation Model for Callable Foreign Bonds

This paper models the value of callable foreign bonds, using stochastic calculus, by assuming that the exchange rate follows a geometric Brownian motion process and the arrival time of an early redemption of the bond by the issuer conforms to a negative exponential distribution. The solution to the stochastic model shows that there is a relationship between the call premium and the expected time to the call which is consistent with traditional Black-Scholes pricing formulae. The magnitude of the call premium can be viewed as a signal to the market on a Government treasury's or company's expectations about the future level of interest rates and possible refinancing strategies.

Credibility, Public Debt and Foreign Exchange Intervention

This paper presents a generalized framework where a discretionary government finds it ex-post optimal to create a downward bias in the exchange rate in addition to the inflation bias of Barro-Gordon type. This dual credibility model helps explain the empirical pattern of public debt financing most recently reported by Falcetti and Missale (2000). Most notably, large and developed economies are predicted to have lower inflation and more conventional home currency bonds. The small and emerging economies, on the other hand, are expected to have relatively higher inflation and more foreign currency bonds. This suggests that a judicious use of a portfolio of home and foreign currency bonds may help economies that are in transition to independent central banking.

An Affine Model for International Bond Markets

We present and estimate a parsimonious multi-factor affine term structure model for joint bond markets. We extend the standard affine models by focusing on joint markets and by incorporating the exchange rate dynamics in the estimation procedure. Estimation is done by means of a Kalman filter algorithm. We find that our particular three factor model is quite successful in fitting bond correlations, both within and between national bond markets. Moreover, the model sheds light on some of the most persistent puzzles in empirical finance. Finally, we apply the model to test for international diversification gains in unhedged bond portfolios, conditional on the information that is present in the term structures of both countries. We find that exchange rate risk is sufficiently priced such that the inclusion of foreign bonds allows for an improved risk-return trade-off from the perspective of a domestic investor.

The role of index bonds in universal currency hedging

This study examines the demand for index bonds and their role in hedging risky asset returns against currency risks in a complete market where equity is not hedged against inflation risk. Avellaneda's uncertain volatility model with non-constant coefficients to describe equity price variation, forward price variation, index bond price variation and rate of inflation, together with Merton's intertemporal portfolio choice model, are utilized to enable an investor to choose an optimal portfolio consisting of equity, nominal bonds and index bonds when the rate of inflation is uncertain. A hedge ratio is universal if investors in different countries hedge against currency risk to the same extent. Three universal hedge ratios (UHRs) are defined with respect to the investor's total demand for index bonds, hedging risky asset returns (i.e. equity and nominal bonds) against currency risk, which are not held for hedging purposes. These UHRs are hedge positions in foreign index bond portfolios, stated as a fraction of the national market portfolio. At equilibrium all the three UHRs are comparable to Black's corrected equilibrium hedging ratio. The Cameron-Martin-Girsanov theorem is applied to show that the Radon-Nikodym derivative given under a P -martingale, the investor's exchange rate (product of the two currencies) is a martingale. Therefore the investors can agree on a common hedging strategy to trade exchange rate risk irrespective of investor nationality. This makes the choice of the measurement currency irrelevant and the hedge ratio universal without affecting their values.

Foreign Bonds: Not a Strategic Asset

Theorists have tried to make a case for adding foreign bonds to a U.S. fixed-income portfolio on the basis of the beneficial effects of, first, unhedged foreign bonds; then, hedged foreign bonds; and recently, high-yield foreign bonds. The only approach that makes sense in light of the historical evidence, however, is for portfolio managers to move in and out of foreign bonds as indicated by market conditions.

Foreign Bonds: A Strategic Asset

Foreign bonds can be used opportunistically as a tactical asset or strategically as a permanent part of an investor's asset allocation. The strategic case for foreign bonds, however, can be made only for hedged foreign bonds. The strategic argument for foreign bonds rests on risk reduction: Because world bond markets are not perfectly correlated, the addition of currency-hedged foreign bonds into a domestic bond portfolio will lower portfolio volatility.

Investigating a Debt Channel for the Smoot-Hawley Tariffs: Evidence from the Sovereign Bond Market

I examine the change in prices of foreign sovereign dollar bonds over several weeks in 1930 that marked major legislative progress for the Smoot-Hawley tariffs. If the market was preoccupied by anticipated debt-repayment problems arising from the tariffs, this should be visible in the cross-countty pattern of bond prices. The bond price data are compared to indicators of country sensitivity to the tariffs and debt service. A significant relationship is found for bond price changes in June 1930, but the size of the effect is very small. Analysis at the regional and individual country level reveals some puzzling cases.

Threat of a capital levy, expected devaluation and interest rates in France during the interwar period

In this paper we try to isolate and measure the respective importance of political and economic aspects in two critical episodes of France interwar. We do this by separating expectations of taxation and of devaluation that are implicitly included in the prices of various categories of French and foreign bonds. Concerning the 1924–26 crisis, we show first that there was no expectation of a government default; second that the rise of interest rates in 1925 results from expectations of a capital levy; third that no hyperinflation was ever expected. After stabilisation, we show that the markets expected an appreciation of the franc up to 1931 and a devaluation afterwards.

An Empirical Investigation of Factors Affecting the Selection of Markets for Foreign Bond Issues

This study investigates factors affecting the selection of markets for issuing foreign bonds and assesses the increase in the likelihood of issuing in a given market when certain variables are present. Logistic regression models evaluate similarity/diversity of accounting systems; disclosure levels; and the existence of a parent/subsidiary and/or an equity listing in the market country as independent variables. The results support the hypothesis that accounting diversity is an influencing factor in selection of a market for issuing foreign bonds.

Capital income taxation and risk-taking in a small open economy

How do capital income taxes affect household portfolio choice and growth? We approach this question within the context of a stochastic model of a small open economy in which taxes on income from domestic capital (equity) and foreign bonds affect household portfolio choice, welfare and the growth rate of the economy. The theoretical and numerical analysis demonstrates the important role that risk plays in determining the mean and variability of growth as well as the conditions under which a higher tax rate can be welfare improving. To shed more light on the complex theoretical interaction between taxes and risk-taking we estimate a reduced-form multinomial probit model of household portfolio choice using the method of simulated moments. The empirical evidence is in stark contrast to the conventional wisdom—we find that higher taxes make it less likely that the household will hold risky assets.

Real business cycles in an open economy: An application to Germany

Real Business Cycles in an Open Economy: An Application to Germany. — This paper discusses a stochastic, dynamic-optimizing model of an open economy. It is closely related to small open economy models, but differs by introducing an upward-sloping supply curve of foreign bonds. The model is calibrated to match the long-run features of Germany. The simulations show that the model is consistent with the observed regularities of German business fluctuations.

Cross-Linking of Gelatin with Carbodiimides

Carbodiimides were employed for cross-linking of gelatin through amide bond formation to avoid any foreign bond incorporation into the cross-linked gelatin molecules. Cross-linking of gelatin was performed not in aqueous solution but in the form of a film under a heterogenous condition. Ethanol-water mixtures were used as the reaction medium to prevent dissolution of gelatin films. The optimal ethanol concentration in the ethanol-water mixtures was around 80 vol%, and the water content of the cross-linked gelatin film attained after swelling with water at 25 degrees C was as low as 55 wt%. A water-soluble carbodiimide (l-ethyl-3[3-dimethylaminoprophyl] carbodiimide) was more effective for gelatin cross-linking than a water-insoluble carbodiimide (1,3-dicyclohexyl carbodiimide). The optimal temperature for cross-linking with the water-soluble carbodiimide ranged between 15 and 25 degrees C. It was concluded that gelatin cross-linking with carbodiimides is as effective as that with glutaraldehyde, which is most widely used despite the toxicity, at least, so far as the water content of cross-linked gelatin film is concerned.

Capital flows and net international investment

This paper analyzes the effect of stochastic terms of trade and commodity preferences on international capital flows and the net asset position of a country. Investors hold foreign assets if excess return from foreign bonds is positive. The demand for foreign assets to hedge against the unanticipated changes in terms of trade is an increasing function of expenditure on imports, if the product of relative risk tolerance and consumption expenditure elasticity of imports is less than the price elasticity of imports. The paper also shows that the net international investment in a country is a decreasing function of the excess return from foreign industry and the rate of change of the terms of trade but an increasing function of their variances, cross-price elasticity of domestic good, price elasticity and consumption expenditure elasticity of imports. An increase in the expenditure on imports may result in a decrease or increase in the net international investment depending on whether the product of relative risk tolerance and consumption expenditure elasticity of imports is less or greater than the price elasticity of imports. JEL: F36, G15.

An Expanded Graphical Representation of the Portfolio Balance Model of Exchange Rate Determination

The traditional one-diagram representation of the portfolio balance model gets high marks for conciseness and efficiency but falls short in providing an intuitive understanding of the forces that drive the model. This paper offers an expanded graphical representation of the model. It features a diagram for each of the three assets considered by the portfolio balance model, domestic bonds, foreign bonds, and domestic money. The purpose is to make the economic adjustments that are taking place in the model's markets more intuitively obvious.

Twin debt reduction, government policies and interdependence

A two-country model with a portfolio choice between money and imperfectly substitutable domestic and foreign bonds, a floating exchange rate and perfect foresight is presented. Account is taken of capital accumulation, government debt and current account dynamics. Numerical methods, including extensive sensitivity analysis, are used to trace the results and spill over effects of a cut in government spending, aimed at the reduction of both external and government debt. This restrictive policy is conducted in a country with nominal wage rigidity, while the passive country is featured by real wage rigidity. The difference between lump sum and progressive income tax on the one hand and bond versus money financing of the budget deficit on the other, are analysed.