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

Cho-Hoi Hui, Chi-Fai Lo and Po-Hon Chau
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Cho-Hoi Hui: Hong Kong Monetary Authority
Chi-Fai Lo: The Chinese University of Hong Kong
Po-Hon Chau: The Chinese University of Hong Kong

No 72016, Working Papers from Hong Kong Institute for Monetary Research

Abstract: Based on an analogy between an economy¡¯s currency price and a firm¡¯s stock price, this paper develops a two-factor pricing model with closed-form solutions for US dollar-denominated sovereign bonds in which foreign exchange rates and US risk-free interest rates are the stochastic factors to study the dynamic linkage between the sovereign bond spreads and exchange rates in emerging markets. The numerical results during the pre-crisis (2003 - 2007) and post-crisis (2009 - 2014) periods and the associated error analysis show that the model credit spreads can broadly track the market credit spreads of the sovereign bonds of Brazil, Colombia, Mexico, the Philippines, Russia and Turkey. The results are consistent with empirical evidence of a connection between sovereign credit spreads and exchange rates, and the well-documented studies about twin sovereign debt and currency crises in emerging markets.

JEL-codes: G13 G21 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2016-05
New Economics Papers: this item is included in nep-mon and nep-sea
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Citations: View citations in EconPapers (2)

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