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Up From Sin: A Portfolio Approach To Financial Salvation

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  • Randall DODD
  • Shari SPIEGEL

Abstract

In this paper, we develop a proposal with the potential to greatly improve the ability of developing countries to reduce their exposure to other countries´ interest rate and exchange rate volatility and to lower their cost of raising capital abroad. The key to achieving these goals is for developing countries to borrow in their own currencies and for investors to lend by creating portfolios of local-currency government debt securities that employ the risk management technique of diversification to generate a return-to-risk that competes favourably with other major capital market security indices. We show, based on data from the early 1990s, that a portfolio of emerging market local currency debt can generate rates of return relative to risk that compete with those of major securities indices in international capital markets. It bears noting that the early 1990s witnessed several severe shocks to international capital markets, including the crises in East Asia, the Russian Federation and Brazil, and the failure of Long-Term Capital Management. We also analyse the implications of deploying such a policy for attracting capital to developing countries, the impact on the stability of their financial systems and on their costs of borrowing, and the implications for future development of local capital markets.

Suggested Citation

  • Randall DODD & Shari SPIEGEL, 2005. "Up From Sin: A Portfolio Approach To Financial Salvation," G-24 Discussion Papers 34, United Nations Conference on Trade and Development.
  • Handle: RePEc:unc:g24pap:34
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    File URL: http://www.unctad.org/en/Docs/gdsmdpbg2420051_en.pdf
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    References listed on IDEAS

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    1. Gerard Caprio & Patrick Honohan, 2008. "Banking Crises," Center for Development Economics 2008-09, Department of Economics, Williams College.
    2. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, vol. 66(2), pages 387-414, December.
    3. Enrica Detragiache & Asli Demirgüç-Kunt, 1998. "Financial Liberalization and Financial Fragility," IMF Working Papers 98/83, International Monetary Fund.
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    Cited by:

    1. Ronald U. Mendoza, 2007. "A Compendium of Policy Instruments to Enhance Financial Stability and Debt Management in Emerging Market Economies," Working Papers 48, United Nations, Department of Economics and Social Affairs.
    2. Korinek, Anton, 2011. "Foreign currency debt, risk premia and macroeconomic volatility," European Economic Review, Elsevier, vol. 55(3), pages 371-385, April.

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