Foreign Investors in Local-Currency Bond Markets: Implications for Bond Yields and Exchange Rates

Pierre De Leo (), Lorena Keller (), Giuliano Simoncelli (), Mauricio Villamizar Villegas () and Tomas Williams

No 2026-007, Working Papers from The George Washington University, The Center for Economic Research

Abstract: When foreign investors acquire local-currency bonds, they must also exchange foreign for local currency. In a model with intermediation frictions, foreign inflows thus generate correlated movements in intermediaries' bond and currency positions, and, in turn, in term and currency premia. Using data from Colombia's bond and foreign exchange markets, we show that this mechanism accounts for key empirical patterns in intermediaries’ positions, bond yields, and exchange rates—including during inflow episodes, and in response to asset purchase policies. Consistent with the model, countries with more prevalent unhedged foreign investor flows exhibit stronger positive comovement between bond and currency returns.

Keywords: foreign investors; local-currency bond markets; exchange rates; bond yields; financial intermediaries; capital flows. (search for similar items in EconPapers)
JEL-codes: E43 E52 F31 G12 (search for similar items in EconPapers)
Pages: 61 pages
Date: 2026-04
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