IDEAS home Printed from
   My bibliography  Save this paper

Gauging Liquidity Risk in Emerging Market Bond Index Funds


  • Serge Darolles

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

  • Jérémy Dudek
  • Gaëlle Le Fol

    (DRM - Dauphine Recherches en Management - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)


ETFs and index funds have grown at very rapid rates in recent years. Originally launched totrack some large liquid indices in developed markets, they now also concern less liquid assetclasses such as emerging market bonds. Illiquidity certainly affects the quality of the replication,and in particular, liquidity might increase the tracking error of any index fund, i.e., thedifference between the fund and the benchmark returns. The tracking error is then the firstcharacteristic that investors consider when they select index funds. In this paper, we beginfrom the CDS-bond basis to simulate the tracking error (TE) of a hypothetical well-diversifiedfund investing in the emerging market bond universe. We compute the CDS-bond basis andthe tracking error for 9 emerging market sovereign entities: Brazil, Chile, Hungary, Mexico,Poland, Russia, South Africa, Thailand and Turkey. All of these countries are included inthe MSCI Emerging Market Debt in Local Currency index. Our sample period ranges fromJanuary 1, 2007 to March 26, 2012. Using a Regime Switching for Dynamic Correlations(RSDC) model, we show that the country-by-country tracking error is reduced by the diversificationat the fund level. Moreover, we show that this diversification effect is less effectiveduring crisis periods. This loss of diversification benefits is the main risk of index funds when they are designed to create a liquid exposure to illiquid asset classes

Suggested Citation

  • Serge Darolles & Jérémy Dudek & Gaëlle Le Fol, 2016. "Gauging Liquidity Risk in Emerging Market Bond Index Funds," Post-Print hal-01500712, HAL.
  • Handle: RePEc:hal:journl:hal-01500712
    DOI: 10.15609/annaeconstat2009.123-124.0247

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Other versions of this item:

    More about this item


    Emerging Markets; Sovereign Debt Market; Liquidity Risk Management; Dynamic Correlation; Regime Switching Models Index funds; Bond markets; Liquidity; Liquidity risk; Economic statistics; Correlations; Portfolio diversification; Investment risk; Liquids;
    All these keywords.

    JEL classification:

    • C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hal:journl:hal-01500712. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CCSD (email available below). General contact details of provider: .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.