Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets
North American Journal of Economics and Finance, Forthcoming
Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 07/2016
20 Pages Posted: 11 May 2016 Last revised: 5 Aug 2022
There are 2 versions of this paper
Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets
Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets
Date Written: November 29, 2017
Abstract
This working paper was written by Cho-Hoi Hui (Hong Kong Monetary Authority), Chi-Fai Lo (The Chinese University of Hong Kong) and Po-Hon Chau (The Chinese University of Hong Kong).
Using data on Brazil, Colombia, Mexico, the Philippines, Russia and Turkey, our empirical results show that the exchange rates of their currencies have adequate explanatory power in explaining their US dollar-denominated sovereign bonds, particularly in the post-global financial crisis period. We develop a two-factor pricing model with closed-form solutions for the sovereign bonds in which the correlated factors are foreign exchange rates and US risk-free interest rates that follow a double square-root process relevant in the low interest rate environment. The numerical results and associated error analysis show that the model credit spreads can broadly track the market credit spreads.
Keywords: Sovereign risk; Bond pricing model; Exchange rates; Emerging markets
JEL Classification: G13; G21; G28
Suggested Citation: Suggested Citation