Global Spillovers into Domestic Bond Markets in Emerging Market Economies

Abstract

While fiscal conditions remain healthier than in advanced economies, emerging economies continue to be exposed to negative spillovers if global conditions were to become less favorable. This paper finds that domestic bond yields in emerging economies are heavily influenced by two international factors: global risk appetite and global liquidity. Using a novel approach, the analysis goes on to show that the vulnerability of emerging economies to these factors is not uniform but rather depends on country specific characteristics, namely fiscal fundamentals, financial sector openness and the external current account balance.

Interrelations of U.S. market fears and emerging markets returns: Global evidence

“…Chen (2014) highlights the dominant role played by VIX in linking the expected market volatilities of the United States, Canada, Germany, and Japan. Jaramillo and Weber (2013) show that bond yields in EMs are heavily influenced by global risk appetite as proxied by VIX. The author shows that an increase in VIX lowers stock market returns, bond yields, and currency values in Australia and New Zealand.…”

“…Nikkinen and Sahlström (2004) find that changes in VIX are the leading source of uncertainty in U.K., German, and Finish equity markets. Jaramillo and Weber (2013) show that bond yields in EMs are heavily influenced by global risk appetite as proxied by VIX. However, none of these international market studies examine the predictive power of VIX for equity returns in the worldwide regional EMs as well as in overall EMs and FMs.…”

Bond market integration of emerging economies and bilateral linkages

“…() found strong evidence of spillover effects in the sovereign bond market from advanced to emerging economies. Jaramillo and Weber (,b) estimated that domestic bond yields in emerging economies are significantly influenced by global risk appetite and liquidity conditions. On the contrary, Peiris () showed that greater foreign participation in the government bond market tends to reduce volatility in bond yields in emerging markets.…”

“…Covering the period 1999–2007, Büttner and Hayo () found that market capitalisation, interest rate spreads and business cycle synchronisation are the major determinants of stock market integration among EU countries. Jaramillo and Weber (,b) showed that fiscal fundamentals, financial sector openness and the external current account balance play a leading role in explaining the global spillovers in the emerging bond markets.…”

Emerging market economies and the world interest rate

“…Our paper extends their work by more thoroughly estimating the dynamics of the world interest rate, relying on a large and updated sample of countries, and, most importantly, using the estimates to gauge the extent to which emerging markets are integrated into world capital markets. Jaramillo and Weber (2013) rely on a common factor approach, as we do, to examine yields in emerging markets, but do not estimate a FAVAR; they focus primarily on estimating common factors across emerging markets and do not link interest rates in developed economies to developing economies.…”