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Exchange Rate Dynamics and US Dollar-denominated Sovereign Bond Prices in Emerging Markets

Author

Listed:
  • Cho-Hoi Hui

    (Hong Kong Monetary Authority)

  • Chi-Fai Lo

    (The Chinese University of Hong Kong)

  • Po-Hon Chau

    (The Chinese University of Hong Kong)

Abstract

Based on an analogy between an economy¡¯s currency price and a firm¡¯s stock price, this paper develops a two-factor pricing model with closed-form solutions for US dollar-denominated sovereign bonds in which foreign exchange rates and US risk-free interest rates are the stochastic factors to study the dynamic linkage between the sovereign bond spreads and exchange rates in emerging markets. The numerical results during the pre-crisis (2003 - 2007) and post-crisis (2009 - 2014) periods and the associated error analysis show that the model credit spreads can broadly track the market credit spreads of the sovereign bonds of Brazil, Colombia, Mexico, the Philippines, Russia and Turkey. The results are consistent with empirical evidence of a connection between sovereign credit spreads and exchange rates, and the well-documented studies about twin sovereign debt and currency crises in emerging markets.

Suggested Citation

  • Cho-Hoi Hui & Chi-Fai Lo & Po-Hon Chau, 2016. "Exchange Rate Dynamics and US Dollar-denominated Sovereign Bond Prices in Emerging Markets," Working Papers 072016, Hong Kong Institute for Monetary Research.
    • Handle: RePEc:hkm:wpaper:072016
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    Cited by:

    1. Siklos, Pierre L., 2018. "Boom-and-bust cycles in emerging markets: How important is the exchange rate?," Journal of Macroeconomics, Elsevier, vol. 56(C), pages 172-187.

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    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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