Foreign participation in local currency government bond markets in emerging Asia: Benefits and pitfalls to market stability

Edmund Ho Cheung Ho

Journal of International Money and Finance, 2022, vol. 128, issue C

Abstract: With the objective of reducing the problem of currency mismatch, emerging Asian economies have made a concerted effort to develop the local currency government bond (LCGB) markets since the early 2000s. Since then, foreign investors have had a substantial and growing presence in the markets. This paper examines the effects of foreign participation in the LCGB markets on the yield spread. We show that the effect of high foreign participation on market stability is non-monotonic: During tranquil periods, high foreign participation helps reduce yield spread; however, in times of market distress, high foreign participation asymmetrically exacerbates the widening of the yield spread by a larger magnitude. This effect could be due to foreign investors' concerns about currency risk. This is supported by the estimation that yield spread widening during market distress is mainly driven by the currency risk component, but not the credit risk component. Our results underscore the importance of broadening the domestic investor base in the region, and maintaining a manageable exchange rate expectation and central bank credibility.

Keywords: Foreign holdings; Emerging markets; Local currency government bond; Yield spread; Exchange rate risk (search for similar items in EconPapers)
JEL-codes: C23 G12 G15 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:128:y:2022:i:c:s0261560622001024

DOI: 10.1016/j.jimonfin.2022.102699

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