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

North American Journal of Economics and Finance, Forthcoming

Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 07/2016

20 Pages Posted: 11 May 2016 Last revised: 5 Aug 2022

Multiple version iconThere are 2 versions of this paper

Date Written: November 29, 2017

Abstract

This working paper was written by Cho-Hoi Hui (Hong Kong Monetary Authority), Chi-Fai Lo (The Chinese University of Hong Kong) and Po-Hon Chau (The Chinese University of Hong Kong).

Using data on Brazil, Colombia, Mexico, the Philippines, Russia and Turkey, our empirical results show that the exchange rates of their currencies have adequate explanatory power in explaining their US dollar-denominated sovereign bonds, particularly in the post-global financial crisis period. We develop a two-factor pricing model with closed-form solutions for the sovereign bonds in which the correlated factors are foreign exchange rates and US risk-free interest rates that follow a double square-root process relevant in the low interest rate environment. The numerical results and associated error analysis show that the model credit spreads can broadly track the market credit spreads.

Keywords: Sovereign risk; Bond pricing model; Exchange rates; Emerging markets

JEL Classification: G13; G21; G28

Suggested Citation

Institute for Monetary and Financial Research, Hong Kong, Exchange Rate Dynamics and US Dollar-Denominated Sovereign Bond Prices in Emerging Markets (November 29, 2017). North American Journal of Economics and Finance, Forthcoming, Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 07/2016, Available at SSRN: https://ssrn.com/abstract=2778420 or http://dx.doi.org/10.2139/ssrn.2778420

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