A Free Lunch for Emerging Markets: Removing International Financial Market Imperfections with Modern Finance Instruments

Abstract

Regulations and frictions of the market for emerging market bonds keep up the price of capital demanded by emerging countries. Instruments of modern finance, i.e. a pool of emerging market bonds refinanced via an enhanced Asset Backed Securities structure, can significantly reduce the interest payments. In an extensive simulation study based on empirical data, the cumulated interest savings for a horizon of 10 years amount to up to 44% of the credit sum. The theoretical structure of the transaction is explicitly derived in cooperation with professionals from major commercial banks and thus realistic. The implementation is costless and does neither require institutional reforms nor debt forgiveness and is in line with market forces.

Keywords: emerging markets, financial market imperfections, finance instruments, debt crises, asset backed securities (ABS)

JEL Classification: H63, F34, G