Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets

39 Pages Posted: 23 Dec 2016

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Chi-Fai Lo

The Chinese University of Hong Kong

Po-Hon Chau

The Chinese University of Hong Kong (CUHK)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2, 2016

Abstract

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

Hui, Cho-Hoi and Lo, Chi-Fai and Chau, Po-Hon, Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets (August 2, 2016). Institute of Global Finance Working Paper Vol. 3, No. 1, Paper 3. Available at SSRN: https://ssrn.com/abstract=2889175 or http://dx.doi.org/10.2139/ssrn.2889175

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Chi-Fai Lo

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

Po-Hon Chau

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

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