17 Pages Posted: 19 May 2017 Last revised: 24 May 2017
Date Written: May 23, 2017
Emerging countries governments increasingly issue local currency denominated bonds and foreign investors have been increasing their holdings of these assets. By issuing debt denominated in local currency, emerging countries governments eliminate exchange rate risk. The growing stock of local currency government debt in the financial portfolios of foreign investors increase their diversification and exposure to fast growing economies. In this paper, we highlight some of the risks associated to this recent trend. First, we adopt the CoVaR risk-measure to estimate the vulnerability of individual countries to systematic risk in the market for local currency government debt. Second, we show that our country level estimates of vulnerability are higher the larger the share of local currency debt held by foreign investors. A version of the old adage ”When New York sneezes, London catches a cold,” that described the relationship between the stock markets in these two cities, still applies between individual emerging countries and the aggregate market for local currency government debt.
Keywords: CoVaR, emerging markets, local currency debt, contagion, systemic risk
JEL Classification: C58, F21, F34, G11, G15, G32
Suggested Citation: Suggested Citation
Borri, Nicola, Local Currency Systemic Risk (May 23, 2017). Available at SSRN: https://ssrn.com/abstract=2971049