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Are markets learning? : behavior in the secondary market for Brady bonds

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  • Barbone, Luca
  • Forni, Lorenzo

Abstract

The authors analyze some aspects of the market for Brady bonds (restructured debt in developing countries). They focus on how the debt crisis in Mexico in 1994 affected risk assessment (as measured by the stripped spread) in other Brady countries, especially Poland. Their main finding: The risk premium (in a single country) has a behavior (one unit root), consistent with the hypothesis that it reflects new market information. Among stripped yields, co-movements of sovereign risk premia were stronger during the period of highest volatility in the Mexican crisis. In the case study of Mexico and Poland, they do not reject cointegration for the period July 1994-July 1995; they do reject it for July 1995-July 1996. The crisis had a strong permanent effect on risk assessment in Mexico (about 55 basis points). Different Brady bonds responded differently to the Mexican crisis. Countries with similar pre-crisis means and volatility reacted similarly (in terms of absolute deviation and the degree of co-movement with the Mexican bonds). Other factors (region, oil producers, date of Brady deal) did not explain observed patterns. There was convergence of volatility during the highly volatile period of the Mexican crisis. These results suggest that traders'behavior in assessing the sovereign risk of Brady countries is not constant over time, and responds especially to the level of market uncertainty. Herd behavior increases with risk, leading (in a volatile environment) to even more volatility. Learning is likely to spill over because traders have limited experience with, and limited information about, developing countries. The decrease in co-movements of sovereign risk premia in the second period of the sample could indicate that markets were learning -that is, gathering information about, and experience in, the developing countries, so that the issue of learning spillover was less relevant. But it could also signal that no relevant shock existed to generate such spillover effects, although the market was still vulnerable to country-specific shocks. On that issue, further research is needed.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1734.

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Date of creation: 28 Feb 1997
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Handle: RePEc:wbk:wbrwps:1734

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Keywords: Banks&Banking Reform; Payment Systems&Infrastructure; International Terrorism&Counterterrorism; Economic Theory&Research; Environmental Economics&Policies; Banks&Banking Reform; Environmental Economics&Policies; Financial Intermediation; Insurance&Risk Mitigation; Economic Theory&Research;

References

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  1. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1996. "Contagious Currency Crises," NBER Working Papers 5681, National Bureau of Economic Research, Inc.
  2. Campbell, John & Perron, Pierre, 1991. "Pitfalls and Opportunities: What Macroeconomists Should Know about Unit Roots," Scholarly Articles 3374863, Harvard University Department of Economics.
  3. Vassilis A. Hajivassiliou, 1989. "Do the Secondary Markets Believe in Life After Debt?," Cowles Foundation Discussion Papers 911, Cowles Foundation for Research in Economics, Yale University.
  4. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  5. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  6. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  7. Carmen M. Reinhart & Sara Calvo, 1996. "Capital Flows to Latin America: Is There Evidence of Contagion Effects?," Peterson Institute Press: Chapters, in: Guillermo A. Calvo & Morris Goldstein & Eduard Hochreiter (ed.), Private Capital Flows to Emerging Markets After the Mexican Crisis, pages 151-171 Peterson Institute for International Economics.
  8. Mills, Terence C & Mills, Alessandra G, 1991. "The International Transmission of Bond Market Movements," Bulletin of Economic Research, Wiley Blackwell, vol. 43(3), pages 273-81, July.
  9. Ozler, Sule, 1993. "Have Commercial Banks Ignored History?," American Economic Review, American Economic Association, vol. 83(3), pages 608-20, June.
  10. Claessens, Stijn & Oks, Danel & van Wijnbergen, Sweder, 1994. "Interest Rates, Growth and External Debt: The Macroeconomic Impact of Mexico's Brady Deal," CEPR Discussion Papers 904, C.E.P.R. Discussion Papers.
  11. Ozler, Sule & Huizinga, Harry, 1991. "How factors in creditor countries affect secondary market prices for developing country debt," Policy Research Working Paper Series 622, The World Bank.
  12. Calvo, Guillermo A, 1996. "Capital Flows and Macroeconomic Management: Tequila Lessons," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 1(3), pages 207-23, July.
  13. Scharfstein, David. & Stein, Jeremy C., 1988. "Herd behavior and investment," Working papers WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  14. Claessens, Stijn & van Wijnbergen, Sweder, 1993. "Secondary Market Prices and Mexico's Brady Deal," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 967-82, November.
  15. Claessens, Stijn & Pennacchi, George, 1992. "Deriving developing country repayment capacity from the market prices of sovereign debt," Policy Research Working Paper Series 1043, The World Bank.
  16. Doukas, John, 1989. "Contagion effect on sovereign interest rate spreads," Economics Letters, Elsevier, vol. 29(3), pages 237-241.
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Cited by:
  1. Budina, Nina & Mantchev, Tzvetan, 2000. "Determinants of Bulgarian Brady bond prices - an empirical assessment," Policy Research Working Paper Series 2277, The World Bank.
  2. Julio Nogués & Martín Grandes, 2001. "COUNTRY RISK: Economic Policy, Contagion Effect or Political noise?," Journal of Applied Economics, Universidad del CEMA, vol. 0, pages 125-162, May.

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