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Foreign Investors in Local-Currency Bond Markets: Implications for Bond Yields and Exchange Rates

Author

Listed:
  • Pierre De Leo

  • Lorena Keller

  • Giuliano Simoncelli

  • Mauricio Villamizar Villegas

  • Tomas Williams

Abstract

When foreign investors acquire local-currency bonds, they must also exchange foreign for local currency. In a model with intermediation frictions, foreign inflows thus generate correlated movements in intermediaries' bond and currency positions, and, in turn, in term and currency premia. Using data from Colombia's bond and foreign exchange markets, we show that this mechanism accounts for key empirical patterns in intermediaries’ positions, bond yields, and exchange rates—including during inflow episodes, and in response to asset purchase policies. Consistent with the model, countries with more prevalent unhedged foreign investor flows exhibit stronger positive comovement between bond and currency returns.

Suggested Citation

  • Pierre De Leo & Lorena Keller & Giuliano Simoncelli & Mauricio Villamizar Villegas & Tomas Williams, 2026. "Foreign Investors in Local-Currency Bond Markets: Implications for Bond Yields and Exchange Rates," Working Papers 2026-007, The George Washington University, The Center for Economic Research.
    • Handle: RePEc:gwc:wpaper:2026-007
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    Keywords

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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