Local Currency Bond Risk Premia: A Panel Evidence on Emerging Markets

28 Pages Posted: 13 Aug 2018

See all articles by Oguzhan Cepni

Oguzhan Cepni

Government of the Republic of Turkey - Central Bank of the Republic of Turkey

Ibrahim Guney

Government of the Republic of Turkey - Central Bank of the Republic of Turkey

Date Written: July 27, 2018

Abstract

This paper investigates the source of variation in emerging market (EM) local currency bond risk premium by employing panel fixed effects regression model. Moreover, we use the methodology of dynamic factor model for large datasets to investigate the possible linkages between excess bond return and economic activity. We provide evidence that macroeconomic and financial variables contain valuable information in explaining local currency bond excess returns. Additionally, we extend our analysis with a panel threshold estimation to investigate how the influence of different factors may vary in different states of the markets depending on the level of global risk appetite. The results show that investors pay more attention to changes in macroeconomic fundamentals when the global risk aversion is high. Also, the influence of exchange rate volatility is more pronounced during the time of market stress. On the other hand, positive credit rating changes decrease the country risk premium which results in lower bond risk premium in tranquil times. Overall, these findings imply that global investors view the local currency debt market as a separate asset class and explore potential diversification benefit from investing in emerging markets by differentiating meaningfully in terms of macroeconomic and financial fundamentals.

Keywords: local currency bond risk premium, dynamic factor model, emerging markets, panel regression

JEL Classification: C55, E44, G15, H63, O16

Suggested Citation

Cepni, Oguzhan and Guney, Ibrahim, Local Currency Bond Risk Premia: A Panel Evidence on Emerging Markets (July 27, 2018). Available at SSRN: https://ssrn.com/abstract=3221115 or http://dx.doi.org/10.2139/ssrn.3221115

Oguzhan Cepni (Contact Author)

Government of the Republic of Turkey - Central Bank of the Republic of Turkey ( email )

Istiklal Cad. 10 Ulus
06100 Ankara, Ankara 06050
Turkey

Ibrahim Guney

Government of the Republic of Turkey - Central Bank of the Republic of Turkey ( email )

Istiklal Cad. 10 Ulus
06100 Ankara, Ankara 06050
Turkey

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