Foreign Participation in Local Currency Bond Markets
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.
The authors thank William Griever, Thomas Jans, and Denis Petre for invaluable assistance with data; JP Morgan for providing data on bond returns; and Jillian Faucette, Tamara Hayford, and Sara Holland for research assistance. We also thank for helpful comments David Cushman (the editor), Morris Goldstein, Bill Helkie, Olivier Jeanne, Steve Kamin, Ross Levine, Ugo Panizza, Vincent Reinhart, Charles Thomas, Joachim Voth, Jon Wongswan, and seminar participants at Trinity College International Bond and Debt Market Integration Conference, Berkeley Conference on Global Imbalances and Asian Financial Markets, Darden Conference on Investing in Emerging Markets, CEPR/Gerzensee Conference on International Capital Flows, IF Monday Workshop, IMF Research Seminar, Loyola College, and University of North Carolina. All errors are our own. We acknowledge generous support from the Sellinger School Junior Sabbatical Program (Burger ) and the Darden School Foundation (Warnock). The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.
Review of Financial Economics 16: pp. 291-304 (2007) citation courtesy of