International Bond Research Articles

Can fiscal sovereignty be reconciled with fiscal discipline?

Over the past two decades, international bond markets have become the chief disciplinarian of fiscal policy, displacing the International Monetary Fund and the European Union in this role. This trend culminated in the wake of the global financial crisis, as countries that had indulged in moral hazard and fiscal profligacy during the Great Moderation were vulnerable to a sharp rise in sovereign risk premium and in some cases to loss of market access. The article compares the response of new governments in Hungary and United Kingdom to restore policy credibility. A major lesson is that governments that adopt a rules-based fiscal framework, including fiscal watchdogs and transparency norms, are far more successful in anchoring fiscal expectations and in achieving fiscal sovereignty than those that do not.

Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries

This paper empirically analyzes how exchange rate policy affects the issuance and pricing of international bonds for developing countries. We find that countries with less flexible exchange rate regimes pay higher sovereign bond spreads and are less likely to issue bonds. Quantitatively, changing a free-floating regime to a fixed regime decreases the likelihood of bond issuance by 4.6% and increases the bond spread by 1.3% on average. Furthermore, countries with real exchange rate overvaluation have higher bond spreads and higher bond issuance probabilities. Moreover, such positive effects of real exchange rate overvaluation tend to be magnified for countries with fixed exchange rate regimes. Our results suggest that choosing a less flexible exchange rate regime in general leads to higher borrowing costs for developing countries, especially when their currencies are overvalued.

The Role of Bond Markets When Portfolio Choice is Constrained

We develop a two-country international asset pricing model in which some investors face leverage constraints. In contrast to models with a single `world' bond, we show that tightening regulation can lead to the risk free interest rate rising. When demand for borrowing is high, a tightening of the constraint causes the investor to shift his loans from international more into local bond markets, putting upwards pressure on local interest rates. Indeed, he sacrifices diversification to gain more risk exposure, by under diversifying currency risk through international bonds. Exchange rate dynamics give rise to a currency risk premium, making carry trades profitable - even in the benchmark unconstrained economy. Consistent with empirical findings, a sudden binding of constraints can significantly shift exchange rate dynamics, rendering previously set up carry trades unprofitable.

An analysis of global credit risk spreads during crises

PurposeThe purpose of this paper is to model the components of credit risk in primary debt markets and evaluate changes in these factors in times of crisis.Design/methodology/approachThe authors use a unique dataset consisting of nearly 163,000 new loans and bond issues in the USA and internationally during the period January 1992 through December 2005.FindingsThe authors find that credit spreads are related to market liquidity, best represented by total proceeds, ratings and the interaction between maturity and rating. The authors control for various crisis periods, including regional financial crises and find that spreads generally increased in response to the Asian Crisis with the international markets exhibiting the larger increases. There is mixed evidence of asymmetric effects of shocks. In the US loan markets, the adjustment factor reduces forecast variance (Θ1<0). In contrast, the adjustment factor is not significant for US bonds, possibly indicating a more rapid adjustment and greater efficiency in this market. The opposite effect is seen in the international loan and bond markets with Θ1>0, indicating a persistent increase in spread volatility.Originality/valueThe paper extends our understanding of the components of primary credit spreads and the interactions between primary debt markets during crisis periods.

Currency composition of international bonds: The EMU effect

We analyze the impact that the launch of the EMU had on the currency denomination of private international bond issues in 1990–2006 using micro-level data. Our stylized model predicts that the introduction of the euro would lead to an increase in the share of euro-denominated debt and a decline in the share of dollar-denominated debt issued by firms located in countries outside both the United States and the euro area. Moreover, our model predicts that the euro effect would be particularly pronounced for nonfinancial firms. Our empirical results are consistent with these predictions. In addition, we find that among nonfinancial firms, the impact on new issuers is larger than on seasoned issuers. Extending the model to allow for differences in issuance volumes across future monetary union countries prior to integration, we also predict larger increases in euro-denominated issuance among firms from smaller monetary union countries. We confirm this prediction for international bond issues by euro-area firms.

Greece: Request for Extended Arrangement Under the Extended Fund Facility - Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Greece.: Request for Extended Arrangement Under the Extended Fund Facility: Staff Report; Staff Supplement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Greece.

This paper presents the staff report for Greece’s request for an Extended Arrangement under the Extended Fund Facility. The Greek economy fell into deep twin structural deficits after euro adoption. Easy access to financing at low interest rates fuelled rapid borrowing by the private and public sectors. Between euro accession in 2001 and 2009, private sector credit almost doubled in percent of GDP, financed mainly through the domestic banking system. Massive sovereign borrowing from international bond markets pushed government debt from 100 percent of GDP to about 130 percent of GDP during this timeframe.

Bond Futures and Order Imbalance: An International Comparison

Order imbalance methodology is utilized to examine the link between trading activity and returns in the six most liquid international bond futures markets. Order imbalances are strongly related to contemporaneous returns, in the expected direction (i.e. excess buy (sell) orders push down (up) yields, even after controlling for aggregate market volume. There is evidence of contrarian investor behaviour following an increase in yields, but continuation of order imbalances when yields are falling (the prices of bond futures are rising). International bond futures markets are strongly intertwined with the US market having a strong influence on the returns and order-flow across all countries; this is likely an indication of the spill-over effect of US macroeconomic data.

Agency and Empowerment under Unlikely Conditions: Exploring How Wartime Displacement Can Promote Community Development

Scholars agree that violent conflict is a major obstacle to development. Wars destroy physical infrastructure, disrupt communication and transportation, encourage capital flight, and discourage foreign and domestic investment. And most important, wars inflict incalculable losses on human populations due to death or displacement. While war is undoubtedly devastating, current research largely fails to explore how wartime displacement can create institutional opportunities to exercise agency, on both an individual and a community level. This paper, based on fieldwork that spans nearly a decade in Guatemala—both during and after the end of its civil war—investigates the conditions under which the tragedy of war can be a catalyst for community development. In particular, refugee testimonies demonstrate that their forced migration contributed to positive outcomes, namely the formation of international relationships and intra-group social bonds, the acquisition of education, useful skills and material goods, and the development of political savvy. The refugee voices featured here give us a different picture of the relationship between community development and war, showing us how—quite counter-intuitively—a situation defined by force and coercion can become one that enables agency and empowerment. For Guatemalan refugees, their displacement to Mexico created an unprecedented opportunity to exercise agency. This, in turn, facilitated the development of social, political, and human capital—three foundational ingredients for successful community development.

Feedback trading and the behavioural ICAPM: multivariate evidence across international equity and bond markets

In this article we develop a ‘behavioural’ Intertemporal Capital Asset Pricing Model (ICAPM) in which the behavioural impetus comes from the feedback trading implications for the autocorrelation of returns. We apply the model in a setting of paired equity and bond investments, employing a bivariate diagonal Berndt–Engle–Kraft–Kroner (BEKK) framework. Our empirics rely on daily equity and bond index returns across six major economies, over the period 1 January 1990 to 30 June 2005. We find evidence supporting the theory that the observed dynamics of serial correlation can be a function of both volatility and conditional covariance (between equity and bonds). Moreover, our behavioural ICAPM shows empirical promise as a useful model of asset pricing in markets that display the feedback trading phenomenon.

The renminbi as an international currency

The dollar in 1914, like the renminbi today, played a negligible role in international trade and payments. Negotiable trade credits denominated in dollars were nonexistent. Manufacturers and wholesalers from other countries seeking to export and import from the United States and, more strikingly, even U.S. exporters and importers themselves, when seeking to obtain credit for a transaction, did so with the intermediation of an investment bank based in London. Those negotiable credit instruments known as bankers acceptances were denominated in sterling, since this was the currency in which London banks were accustomed to dealing. Smaller markets in negotiable trade credits existed in France (in francs) and Germany (in marks) but not in the United States, this despite the fact that by 1914 the United States was the largest trading nation. The dollar similarly played a negligible role as a currency in which to denominate international bonds, even though the U.S. turned from capital importer to capital exporter after 1890. The dollar accounted for just a tiny sliver of the foreign reserves of central banks and governments; only de facto U.S. dependencies like the Philippines held any of their reserves in dollars.

Debt, interest rates, and integration of financial markets

It is commonly believed that higher budget deficits raise interest rates. However, these crowding out effects of increasing public debt have usually been found to be small or non-existent. One explanation is that on globalised bond markets interest rate differentials are offset due to financial integration. This paper tests crowding out, and measures the degree of integration of government bond markets, using spatial modelling techniques. Our main finding is that the crowding out effect of public debt on domestic long term interest rates is small: a 1% increase in the debt ratio pushes up domestic rates by 2 pp at most. Financial integration implies an important spillover effect via international bond markets, but only between OECD, and in particular EU, countries. The feedback effect from these markets on long term interest rates is as important as the domestic crowding out effect of higher public debt. Emerging markets are not as well integrated into international capital markets, causing a stronger crowding out effect.

The Sarbanes-Oxley Act and the Choice of Bond Market by Foreign Firms

This paper examines the economic impact of the Sarbanes-Oxley Act (SOX) by studying foreign firms’ choice of whether to issue bonds in the U.S. public bond market or elsewhere before and after the law's enactment in 2002. After controlling for firm characteristics, bond features, home-country attributes, and market conditions, I find that foreign firms rely less on the U.S. public bond market after SOX. Additionally, some determinants of choosing the U.S. public bond market have changed since the passage of SOX: firms listing equities on U.S. stock exchanges, adopting International Financial Reporting Standards (IFRS), and doing large bond issuances are more likely to choose this market in the post-SOX period than in the pre-SOX period. Overall, these results are consistent with a shift in the expected costs and benefits of choosing the U.S. public bond market following SOX. This paper provides the first evidence about how SOX influences debt financing decisions and alters capital flows across international bond markets.

How much can governments borrow? Financialization and emerging markets government borrowing capacity

ABSTRACT This article considers the varied borrowing capacity of emerging market governments, a key component of the impact on governments of financial globalization. It focuses on the link between the financialization – defined here as the ability to trade risk – and borrowing capacity, analyzing three case study countries: Brazil, Lebanon and Turkey. Both domestic and international bond markets are considered and differences in the ownership of government bonds in the three countries are highlighted. The financialization of different financial market actors is analyzed, concentrating on two of the most important, domestic commercial banks and individual investors, and the financialization of the structure of each market. It is argued that the greater the financialization, the greater the ability to exit or short. This increases the cost of borrowing and increases the likelihood, and severity, of crisis, thereby reducing government borrowing capacity. Comparative event studies from the three countries demonstrate the influence of financialization in crisis, or potential crisis, situations.

The Laws of Geoeconomic Gravity Fulfilled? China's Move Towards Center Stage

For China, the last quarter century has marked the start of a new chapter in its history as it moved back from the margins of history toward centre stage, with global impacts from its soaring trade flows, foreign direct investment inflows, and the centrality of the yuan to developments in international currency markets. WTO membership, achieved in 2001, allowed China to play in setting global trade rules: China surprised many with its constructive technical suggestions for tariff cutting formulae. And its participation (albeit as silent partner) in the Group of 20 that coalesced at the Cancun WTO Ministerial hinted at new negotiating dynamics. For the inattentive, the launch of a manned space flight was a shot across the bow. And, somewhat less conspicuously but of perhaps more immediate significance, China made what London’s Financial Times called a “spectacular return” to the international bond market. China has come so far, so fast, that instinctively one expects - as with any bull market - a consolidation/correction phase; as well, one searches for signposts/benchmarks that chart out the way ahead. We have long been familiar with extrapolations of the size of China’s economy that suggest that China might surpass the US as the world’s largest economy by the middle of the 21st Century. But what does that mean for the way China fits into the global economy (and its political economy) and for the way the global economy works? Is China an economic “power,” and if so, what metrics would give us a sense of how much leverage it might have? And the flip side of this coin matters as well: what do developments in the global economy portend for China? Will China have the period of grace to get its internal affairs in order before it takes on the global roles that almost unavoidably go with the size of its economic footprint? This note takes up these questions in terms of the real economy, international finance, and global economic institutions.

Challenges and Developments in the Financial Systems of the Southeast Asian Economies

This paper discusses the economies and financial systems of Southeast Asia (SEA) and focuses on challenges and developments in the region. Despite the diversity of SEA economies and some important exceptions, most of them are relatively small but growing strongly. Financial deepening differs among SEA economies. Yet in general, equity markets have grown rapidly and bond markets slowly. The main vulnerabilities of the SEA economies stem from volatile capital flows as well as from decreases in export demand. As a result of national and regional policy responses to the Asian Crisis of 1997/98, the soundness of banking systems has improved, and frameworks to deal with foreign currency liquidity problems and to develop bond markets have been established. Due to these efforts, SEA economies have shown considerable resilience during the current global financial and economic crisis. In some economies, macro-prudential measures may have contributed to this resilience. Capital flows during the current crisis have reminded regional authorities of the risks inherent in these flows. Remaining issues for policy makers to consider are the risks presented by the expanding business activities of banks in the capital and real estate markets, and increasing the participation of SMEs and households in the financial system. JEL Classification: F30, F32, F55, G01, G15, G18, G28, N45 Keywords: Southeast Asia, capital flows, financial crises, financial development, international bond markets

International Bond Risk Premia

We identify local and global factors across international bond markets that are poorly spanned by the traditional level, slope and curvature factors but have strong forecasting power for future bond excess returns. Local and global factors are jointly significant predictors of bond returns, where the global factor is closely linked to US bond risk premia and international business cycles. Motivated by our results, we estimate a no-arbitrage affine term structure model for each country in which movements in risk premia are driven by one local and one global factor. Yield loadings for the two factors are estimated to be close to zero while shocks to risk premia account for a small fraction of yield variance. This suggests that the cross-section of yields conveys little information about the return-forecasting factors. We show that shocks to global risk premia cause off-setting movements in expected returns and expected future short-term interest rates, leaving current yields little affected. Furthermore, correlations between international bond risk premia have increased over time, indicating an increase in integration between markets.

Investor Base and Corporate Borrowing: Evidence from International Bonds

Investor Base and Corporate Borrowing: Evidence from International Bonds

Exchange Rates, Macroeconomic Fundamentals and Risk Aversion

This paper shows that under absence of arbitrage opportunities the exchange rate reacts to restore equilibrium in international bond markets. The key factors determining its value are the difference between realized and implicit interest rate differentials, the underlying risk premium in bond markets and changes in market expectations on the long run exchange rate. The application of this model to the macroeconomy reveals the importance of the risk premium for setting monetary policy. We find that a relative increase/decrease in the risk premium between foreign and domestic debt markets increases/decreases the influence of foreign monetary policy for shifting real output.

Shadow Sovereign Ratings for Unrated Developing Countries

We predict sovereign ratings for developing countries that do not have risk ratings from agencies such as Fitch, Moody’s, and Standard and Poor’s. Ratings are important in determining the volume and cost of capital flows to developing countries through international bond, loan, and equity markets. Sovereign rating also acts as a ceiling for the foreign currency rating of sub-sovereign borrowers and can be important for their access to international debt and equity capital. We generate shadow ratings for several developing countries that have never been rated and find that unrated countries are not always at the bottom of the rating spectrum. Several of them are projected to have a “B” or higher rating, in a similar range to that of the emerging market economies with capital market access.

International evidence on bond risk premia

This paper revisits the study of time-varying excess bond returns in international bond markets. Using newly available yield curve data from 10 different countries with independent monetary policy, I test the robustness of Cochrane and Piazzesi (2005). For most countries in my sample, I find more modest predictive power for forward rates than originally found by Cochrane and Piazzesi (2005) for the US. Their single-factor model captures well the predictability in international data, and this factor also tends to have a tent-shape in most countries of my sample. CP factors are more idiosyncratic across countries than yields or forward rates. Finally, I show that the recent financial crisis has significantly affected the predictability of excess bond returns.