The Development of Government Bond Markets in Emerging Economies: Market Structure Matters

Abstract

The secondary market of government bonds or securities is stagnant in emerging economies and nearly non-existent in many low-income economies, though a market making system has widely been recommended as a market development policy over years. Simulation with a system dynamics model indicates that a nearly full-scale market making system would be prudently workable in high-end emerging markets, but not in most emerging economies because of large and unmanageable market risk and funding costs involved in it. All market making systems are partial in market making to varying degrees and build up systemic risk. The emerging market government should be prepared for consequences of its partial market making system or consider a call market or a dealers’ club market for government securities trading according to the phase of its market before introducing a market making system. With a market structure matching its intrinsic liquidity, an emerging market can ensure price discovery and order matching. The selection of market structure matters to secondary market development in emerging economies.

Keywords: government bonds, emerging markets, secondary market, primary dealers, market making, call auction, dealers' club, system dynamics

JEL Classification: H63, O16, 042, P43