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The development of local currency bond markets and uncovered interest rate parity

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  • Park, Cyn-Young
  • Shin, Kwanho

Abstract

This study examines how the growth of local currency bond markets (LCBM) and the expansion of nonbank financial institutions (NBFI) influence the uncovered interest parity (UIP) condition, based on the actual expectations of market participants in emerging market economies (EMEs). Using data from January 1996 to April 2022, we find a reduction in UIP deviations with the growth of LCBMs and the expansion of NBFIs in EMEs. This progress also brings the dynamics of UIP premiums in these markets closer to those seen in advanced economies. Additionally, in EMEs with a larger size of LCBMs, capital flows exhibit increased sensitivity to UIP premiums. However, despite the development of LCBMs, we find strong evidence of the ’original sin redux’ in both advanced and emerging economies, as evidenced by the increase (or decrease) of gross portfolio debt inflows with an appreciating (or depreciating) exchange rate. Additionally, we find that LCBM advancements amplify the impact of actual exchange rate depreciation, but only in EMEs.

Suggested Citation

  • Park, Cyn-Young & Shin, Kwanho, 2025. "The development of local currency bond markets and uncovered interest rate parity," Journal of International Money and Finance, Elsevier, vol. 154(C).
    • Handle: RePEc:eee:jimfin:v:154:y:2025:i:c:s0261560625000452
    DOI: 10.1016/j.jimonfin.2025.103310
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    Cited by:

    1. Jamel Boukhatem, 2024. "The effects of financial risk components on local-currency bond markets: theory and empirical evidence," SN Business & Economics, Springer, vol. 4(4), pages 1-19, April.

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    More about this item

    Keywords

    Uncovered interest parity; Local currency bond markets; Emerging economies; Nonbank financial institutions; Capital inflows;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F62 - International Economics - - Economic Impacts of Globalization - - - Macroeconomic Impacts
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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