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

37 Pages Posted: 7 Jun 2018

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)

Date Written: December 2017

Abstract

The study conducts an empirical test on dollar-denominated sovereign credit spreads in emerging markets, including Brazil, Colombia, Mexico, the Philippines, the Russian Federation, and Turkey to examine their relationship with each country’s exchange rate and the United States (US) Treasury yields. The relationship between each country’s exchange rate and the pricing of each country’s US-dollar denominated sovereign bonds was particularly strong after the global financial crisis of 2008–2009. A two-factor pricing model is developed with closed-form solutions for the sovereign bonds. The correlated factors in the model are foreign exchange rates and US risk-free interest rates that follow a double square-root process relevant in a low interest rate environment. The numerical results and associated error analysis show that the model credit spreads can broadly track market credit spreads.

Keywords: bond pricing model, emerging markets, exchange rates, sovereign risk

JEL Classification: G13, G21, G28

Suggested Citation

Hui, Cho-Hoi and Lo, Chi-Fai and Chau, Po-Hon, Exchange Rate Dynamics and United States Dollar-Denominated Sovereign Bond Prices in Emerging Markets (December 2017). ADBI Working Paper 530. Available at SSRN: https://ssrn.com/abstract=3187948 or http://dx.doi.org/10.2139/ssrn.3187948

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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