Limited Participation and Local Currency Sovereign Debt

71 Pages Posted: 31 May 2017 Last revised: 31 Jan 2019

See all articles by Nicola Borri

Nicola Borri

LUISS University - Department of Economics and Finance

Kirill Shakhnov

Einaudi Institute for Economics and Finance (EIEF)

Date Written: November 15, 2018

Abstract

Governments in emerging countries are increasingly issuing bonds in local currencies and foreign holdings of these bonds have been growing significantly. Motivated by these novel facts, we build a model where local (foreign) investors specialize in local (foreign) currency bonds. After paying a fee, foreign investors can also buy local currency bonds. Based on recent low U.S. interest rates, the model predicts the documented increase in foreign holdings and correlation between local and foreign currency bond returns, and spillovers of foreign shocks to local markets. Higher expected future U.S. interest rates imply sharp reductions in foreign holdings.

Keywords: local currency, emerging countries, limited arbitrage, market segmentation

JEL Classification: E43, G12, F31, G11

Suggested Citation

Borri, Nicola and Shakhnov, Kirill, Limited Participation and Local Currency Sovereign Debt (November 15, 2018). Available at SSRN: https://ssrn.com/abstract=2978127 or http://dx.doi.org/10.2139/ssrn.2978127

Nicola Borri (Contact Author)

LUISS University - Department of Economics and Finance ( email )

viale Romania, 32
Rome, 00197
Italy

HOME PAGE: http://docenti.luiss.it/borri/

Kirill Shakhnov

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

HOME PAGE: http://sites.google.com/site/kshakhnov/

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