TAILIEUCHUNG - Understanding Emerging Market Bonds Claude B. Erb Liberty Mutual Insurance Company

Economic growth in India has picked up in recent years, and like other integrating Asian economies, it too requires large amounts of efficiently intermediated capital to sustain its development. However, an important constraint to financial reform has been dealing with the vestiges of financial “repression”— deliberate policies that crowd out the private sector from credit markets and limit the ability of financial markets to develop as intermediaries for saving. Years of deficit financing have led to large-scale intervention and state ownership of financial intermediation. High statutory reserve requirements, extensive directed lending to priority sectors (including mandatory holdings of government. | Understanding Emerging Market Bonds Claude B. Erb Liberty Mutual Insurance Company Campbell R. Harvey Duke University National Bureau of Economic Research Tadas E. Viskanta Draft as of October 21 1999 Abstract Although emerging market bonds have been a investment option for centuries only in the last decade have we had the data to begin to study their behavior. According to this data emerging market bonds have had high volatility negative skewness and low but increasing correlation with existing asset classes. Not surprisingly we find that as with other asset classes country risk plays an important role in the pricing of emerging market bonds. We also introduce a measure of market sentiment for emerging market bonds. For many investors the extreme characteristics of emerging market bonds will make it difficult for them to invest for others we provide some insight on means for emerging market bond investments. Introduction The 1990s emerging market bonds have seen nearly a full cycle of sentiment. Starting with their emergence after a decade of default and turmoil. Next the strong performance of emerging market bonds attracted considerable attention and some measure of acceptance. Indeed from 1991 to the summer of 1997 the average returns on emerging market bonds in the 1990s exceeded that of the Standard and Poor s 500 index. At the time we argued Erb Harvey and Viskanta 1997a that any judgment on the viability of emerging market bonds as an asset class was difficult given 1 the short history of data and 2 that characteristics were being measured over a long bull market. Then in 1997 1998 the world capital markets saw two bouts of severe economic and financial crisis. These setbacks not only produced poor returns and some subsequent defaults. It also impeded further interest into the asset class. Much of the research into emerging market bonds was done prior to these economic and financial declines. A number of authors then pointed out some of the benefits to .

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