Comments on "Determinants of Asia-pacific government bond yields"

This paper studies how global and local factors drive local currency (LC) sovereign yields in four Asia-Pacific (AP) countries – China, Korea, Singapore and Indonesia – through the lens of a cross-country term structure model. The analysis distinguishes between the currency risk component of the yields, measured as spreads of LC AP yields over US dollar-denominated AP yields, and the credit risk component, measured as spreads of US dollar-denominated AP yields over US Treasury yields. The authors (Chernov, Creal and Hördahl) proceed in two steps. First, they examine the dynamics of a large observable state vector that includes four US factors – two macro factors and two yield curve factors; and six local factors for each AP country – currency depreciation, two macro factors, the divergence of two local yield factors from the US counterparts and a credit risk factor. US factors are assumed to be autonomous and their dynamics are estimated using a standard vector autoregression (VAR). The local factors are assumed to depend on both their own lags and the lagged US factors in a fashion that is identical across countries (except for the drift) and their dynamics are estimated using panel regressions with fixed country effects. Next, the authors incorporate insights from the panel regressions into an unspanned macro term structure model, in which US yields are driven by the US factors only, local yields are driven by both US factors and each country’s local factors, and the macro factors are not completely spanned by yields. The estimated model suggests that currency risk components are mostly driven by US shocks, while credit risk premiums are mostly driven by local shocks. This paper is a useful contribution to emerging market economy (EME) bond pricing literature, which often focuses on credit risks but largely ignores the currency risk dimension of those bonds.