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Emerging Market Spread Compression; Is it Real or is it Liquidity?

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  • Laura E. Kodres
  • Kristian Hartelius
  • Kenichiro Kashiwase

Abstract

Despite recent turmoil, spreads on emerging market countries' sovereign bonds have fallen dramatically since mid-2002. Some have attributed the fall to improved economic fundamentals while others to ample global liquidity. The paper models spreads and attempts to empirically distinguish between the two factors. The results indicate that fundamentals, as embedded in credit ratings, are very important, but that expectations of future U.S. interest rates and volatility in those expectations are also a key determinant of emerging market spreads.

Suggested Citation

  • Laura E. Kodres & Kristian Hartelius & Kenichiro Kashiwase, 2008. "Emerging Market Spread Compression; Is it Real or is it Liquidity?," IMF Working Papers 08/10, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:08/10
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    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=21546
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    References listed on IDEAS

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    1. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2005. "When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies," NBER Chapters,in: NBER Macroeconomics Annual 2004, Volume 19, pages 11-82 National Bureau of Economic Research, Inc.
    2. Sy, Amadou N. R., 2002. "Emerging market bond spreads and sovereign credit ratings: reconciling market views with economic fundamentals," Emerging Markets Review, Elsevier, vol. 3(4), pages 380-408, December.
    3. Reisen, Helmut, 2003. "Ratings since the Asian crisis," Copublicaciones, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 1790.
    4. Kuttner, Kenneth N., 2001. "Monetary policy surprises and interest rates: Evidence from the Fed funds futures market," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 523-544, June.
    5. Graciela L. Kaminsky & Carmen M. Reinhart & Carlos A. Végh, 2003. "The Unholy Trinity of Financial Contagion," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 51-74, Fall.
    6. Torsten Sløk & Mike Kennedy, 2004. "Factors Driving Risk Premia," OECD Economics Department Working Papers 385, OECD Publishing.
    7. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
    8. Patrick McGuire & Martijn A Schrijvers, 2003. "Common factors in emerging market spreads," BIS Quarterly Review, Bank for International Settlements, December.
    9. Kao, Chihwa, 1999. "Spurious regression and residual-based tests for cointegration in panel data," Journal of Econometrics, Elsevier, vol. 90(1), pages 1-44, May.
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    More about this item

    Keywords

    Credit ratings; Emerging markets; Liquidity; Sovereign Spreads; Fundamentals; bond; bond spreads; market bond; emerging market bond; standard deviation;

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