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Country Insurance Using Financial Instruments

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Author Info

  • Luca Antonio Ricci
  • Marcos Chamon
  • Yuanyan Sophia Zhang

Abstract

The availability of financial instruments related to indices that track global financial conditions and risk appetite can potentially offer countries alternative options to insure against external shocks. This paper shows that while these instruments can explain much of the in-sample variation in borrowing spreads, this fails to materialize in hedging strategies that work well out-of-sample during tranquil times. However, positions on instruments such as those tracking the US High Yield Spread, the VIX, and especially other emerging market CDS spreads can substantially offset adverse movements in own spreads during times of systemic crises. Moreover, high risk countries seem to gain more, as their underlying weaknesses makes them more vulnerable to external shocks. Overall, the limited value in tranquil times, coupled with political economy arguments and innovation costs could justify the limited interest for this type of hedging in practice

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 11/169.

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Length: 35
Date of creation: 01 Jul 2011
Date of revision:
Handle: RePEc:imf:imfwpa:11/169

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Keywords: Economic models; Emerging markets; External shocks; Financial instruments; Risk management; hedging; probability; hedge; minimization; hedge ratios; bond; hedging strategies; standard deviation; hedge ratio; standard deviations; bond spreads; government bond; bonds; probability density; correlation; hedging instruments; correlations; stock market; corporate bond; probability density function; regression analysis; equation; financial innovation; bond spread; high yield bond; stock returns; explanatory power; international capital; credit derivatives; bond yield; hedges; cointegration; statistics; derivatives markets; stock market indices; international interest rates; international financial markets; derivative; corporate bonds; bond rate; functional form; international finance; probabilities; hedging instrument; random sample; emerging market bond; high-yield corporate bonds; global stock market; government bond yield; corporate bond market; skewness; portfolio hedging; financial markets; commodity derivatives; bond market; financial economics; international reserves; futures contracts; data analysis; market bond;

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References

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  1. Ricardo J. Caballero & Stavros Panageas, 2003. "Hedging Sudden Stops and Precautionary Contractions," NBER Working Papers 9778, National Bureau of Economic Research, Inc.
  2. Martín González-Rozada & EduardoLevy Yeyati, 2008. "Global Factors and Emerging Market Spreads," Economic Journal, Royal Economic Society, vol. 118(533), pages 1917-1936, November.
  3. Paolo Mauro & Törbjörn I. Becker & Jonathan David Ostry & Romain Ranciere & Olivier Jeanne, 2007. "Country Insurance," IMF Occasional Papers 254, International Monetary Fund.
  4. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1993. "“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," MPRA Paper 7125, University Library of Munich, Germany.
  5. Fatih Ozatay & Erdal Ozmen & Gulbin Sahinbeyoglu, 2008. "Emerging Market Sovereign Spreads, Global Financial Conditions and US Macroeconomic News," Working Papers 400, Economic Research Forum, revised May 2008.
  6. Lien, Donald & Tse, Yiu Kuen, 2001. "Hedging downside risk: futures vs. options," International Review of Economics & Finance, Elsevier, vol. 10(2), pages 159-169.
  7. Dailami, Mansoor & Masson, Paul R. & Padou, Jean Jose, 2008. "Global monetary conditions versus country-specific factors in the determination of emerging market debt spreads," Journal of International Money and Finance, Elsevier, vol. 27(8), pages 1325-1336, December.
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Cited by:
  1. Comelli, Fabio, 2012. "Emerging market sovereign bond spreads: Estimation and back-testing," Emerging Markets Review, Elsevier, vol. 13(4), pages 598-625.
  2. Fabio Comelli, 2012. "Emerging Market Sovereign Bond Spreads," IMF Working Papers 12/212, International Monetary Fund.
  3. Reda Cherif & Fuad Hasanov, 2012. "The Volatility Trap," IMF Working Papers 12/134, International Monetary Fund.

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