51 Pages Posted: 11 Jul 2001
Date Written: October 28, 2003
This paper finds strong evidence of predictability in Brady bonds, the most liquid emerging debt market, by implementing a new model for credit spreads. Predictability is economically and statistically significant and robust to various considerations. Active management provides US investors in emerging markets with double the buy-and-hold returns at lower risk and the equivalent of free options on Brady bonds. Our analysis suggests that predictability is primarily driven by credit spread deviations from fundamentals, rather than time-varying risk or risk premia. We believe this inefficiency is the result of the restrictions of a non-transparent, institutionally dominated, dealer market and the lack of a well developed derivatives market for emerging country credit risk.
Keywords: Predictability, credit risk, credit spreads, emerging debt markets, Brady bonds, efficiency
JEL Classification: G11, G12, G14, G15
Suggested Citation: Suggested Citation