Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets
39 Pages Posted: 23 Dec 2016
Date Written: August 2, 2016
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-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