Determinants of Emerging Market Sovereign Bond Spreads: Fundamentals Vs Financial Stress

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper analyses the determimants of emerging market sovereign bond spreads by examining the short and long-run effects of fundamental (macroeconomic) and temporary (financial market) factors on these spreads. During the current global financial and economic crisis, sovereign bond spreads widened dramatically for both developed and emerging market economies. This deterioration has widely been attributed to rapidly growing public debts and balance sheet risks. Our results indicate that in the long run, fundamentals are significant determinants of emerging market sovereign bond spreads, while in the short run, financial volatility is a more important determinant of sperads than fundamentals indicators.

Determinants of sovereign spreads in Sri Lanka: global factors and country-specific fundamentals

“…Accordingly, global liquidity is found to have an inverse relationship with sovereign spreads of Sri Lanka, while global volatility seems to have a positive correlation with the same. These results corroborate the findings of Min (1998), Kodres et al (2008), Petrova et al (2010) and Daehler et al (2021).…”

“…Negative impact of FES too is as anticipated: growth in reserves-to-import ratio (RES) reflect increased debt service capacity and thereby reducing the sovereign risk level. These findings are in line with those of Ciarlone et al (2007), Petrova et al (2010) and Presbitero et al (2015).…”

“…As a country that is heavily dependent upon imports while running large trade deficits, the foreign reserves ratio is an important liquidity indicator measuring its ability to pay for foreign goods imported for consumption and investments. As such, Ciarlone et al (2007), Petrova et al (2010) and Daehler et al (2021) find a significant negative association between foreign reserves ratio and perceived default risk. In that light, a country's exchange rate also plays an important role.…”

Analysis of Long-term Equilibrium Relationship Between KRW, RMB, JPY Exchange Rates and International Financial Market Variables: Comparative Analysis of KRW, RMB, JPY

“…The second variable is the 10-year US treasury interest rate. In [38], the author argued that the 10-year U.S. government bond interest rate is the benchmark for the level of interest expected by investors in international financial markets. In [39], the author argued that the determinants of investment capital flowing into emerging economies are largely attributable to supply factors, such as the level of U.S. treasury bond interest rates and preference for safe assets in the international financial market.…”

“…In [44], the author argued that VIX is an important variable that explains the CDS premium in Mexico, Turkey, and South Korea. In [38], the author argued that VIX is a factor that explains the premium on short-term government bonds. In [39], the author stated that the VIX index represents a preference for safe assets in the international financial market and that if the VIX index fall halves, total capital inflows from emerging economies would increase by 11%.…”