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Global Monetary Conditions versus Country-Specific Factors in the Determination of Emerging Market Debt Spreads

  • Mansoor Dailami

    (World Bank)

  • Paul Masson

    (Rotman School of Management, University of Toronto)

  • Jean Jose Padou

    (University of Toronto)

We offer evidence in this paper that US interest rate policy has an important influence in the determination of credit spreads on emerging market bonds over US benchmark treasuries, and therefore on their cost of capital. Our analysis improves upon the existing literature and understanding, by addressing the dynamics of market expectations in shaping views on interest rate and monetary policy changes, and by recognizing non-linearities in the link between US interest rates and emerging market bond spreads, as the level of interest rates affects the market's perceived probability of default and the solvency of emerging market borrowers. For a country with a moderate level of debt, repayment prospects would remain good in the face of an increase in US interest rates, so there would be little increase in spreads. A country close to the borderline of solvency would face a steeper increase in the spreads. Simulations of a 200 basis points (bps) increase in US short-term interest rates (ignoring any change in the US 10 year Treasury rate) show an increase in emerging market spreads ranging from 6 bps to 65 bps, depending on debt/GDP ratios.

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Paper provided by EconWPA in its series International Finance with number 0506003.

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Length: 32 pages
Date of creation: 06 Jun 2005
Date of revision:
Handle: RePEc:wpa:wuwpif:0506003
Note: Type of Document - pdf; pages: 32
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