Working Paper: NBER ID: w12548
Authors: John D. Burger; Francis E. Warnock
Abstract: Countries that cannot attract foreigners to invest in their local currency bonds run the risk of currency mismatches that can result in painful crises. We analyze foreign participation in the bond markets of over 40 countries. Bond markets in less developed countries have returns characterized by high variance and negative skewness, factors that we show are eschewed by U.S. investors. While results based on a three-moment CAPM indicate that it is diversifiable idiosyncratic risk that U.S. investors shun, our analysis suggests that countries can improve foreign participation by reducing macroeconomic instability.
Keywords: Foreign participation; Local currency bonds; Macroeconomic stability; Investor behavior
JEL Codes: F3; G11; G15; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroeconomic instability (E60) | unsatisfactory return characteristics in emerging markets (G15) |
| macroeconomic stability (E60) | foreign participation in local currency bond markets (G15) |
| lower variance of bond returns (G12) | U.S. investor holdings (N22) |
| higher skewness of returns (C46) | U.S. investor holdings (N22) |
| idiosyncratic risk (D81) | U.S. portfolio weights (G15) |