Emerging markets financial sector debt: A Markov‐switching study of interest rate sensitivity

Mariya Gubareva and Benjamin Keddad

International Journal of Finance & Economics, 2022, vol. 27, issue 4, 3851-3863

Abstract: We provide an empirical study on the sensitivity of capital gains of emerging market financial sector debts to the U.S. Treasury market in a three‐state Markov‐switching framework. Specifically, we model the capital gains change in a debt portfolio consisting of emerging market bonds as a linear regression of the capital gains change in a portfolio consisting of U.S. Treasury bonds in which the regression coefficients are allowed to switch between three regimes. Our analysis spans the period 2003–2016. We identify three regimes corresponding to positive sensitivity, insensitivity and negative sensitivity and provide economic explanations of our findings. We find that negative sensitivity regimes mostly occurred during the financial crisis. Our research advances understanding of the financial economics that governs the interdependence of interest rate risk and credit risk. By reassessing interest rate risk management through the prism of the downside risk hedge, our results shed light on how financial institutions may better withstand adverse financial conditions.

Date: 2022
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