Local Currency Bond Returns in Emerging Economies and the Role of Foreign Investors

HKIMR Working Paper No.10/2019

10 Pages Posted: 30 May 2019

See all articles by Inhwan So

Inhwan So

The Bank of Korea

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR)

Jason Wu

Hong Kong Monetary Authority

Date Written: May 30, 2019

Abstract

Foreign investors play a key role in EME sovereign bond markets, in part because their portfolio flows are sensitive to bond returns and are therefore pro-cyclical in nature. This note discusses the implications of the framework proposed by So et al. (2019) which incorporates the risk that arises from the portfolio performance and flows of actively managed bond funds. When the framework is applied to the data, using local currency sovereign bonds of 16 EMEs, preliminary calculations show that local currency sovereign bonds that positively covary with the returns of active funds receive risk premia as compensations for active fund risk. Furthermore, and in line with theory, the price of this risk increases when bond funds experience outflows and the exposure to active funds risk increases with the heightened price of risk. This double effect helps explain why spikes in returns of some EME local currency bonds can be especially large. These results demonstrate how the portfolio performance and flows of actively managed funds help transmit shocks across EMEs.

Keywords: Bond excess returns, Portfolio flows, Institutional investors, Conditional asset pricing

JEL Classification: F31, F34, G15

Suggested Citation

So, Inhwan and Valente, Giorgio and Wu, Jason, Local Currency Bond Returns in Emerging Economies and the Role of Foreign Investors (May 30, 2019). HKIMR Working Paper No.10/2019 . Available at SSRN: https://ssrn.com/abstract=3396287 or http://dx.doi.org/10.2139/ssrn.3396287

Inhwan So (Contact Author)

The Bank of Korea ( email )

Korea, Republic of (South Korea)

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR) ( email )

One Pacific Place, 10th Floor
88 Queensway
Hong Kong
China

Jason Wu

Hong Kong Monetary Authority ( email )

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

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