Long-run determinants of sovereign bonds in emerging markets: Asymmetric nonlinear model

Objectives: From the Asian and Latin American finnancial crises of the 1990s and the 2000s to the current global financial crisis, the sovereign bond spread has been an important indicator to measure country risk. In this paper, we study the asymmetric long-run and short-run determinants of the sovereign bond index, proxied by the Emerging Market Bond Index Plus (EMBI+). EMBI+ is a JPMorgan index capturing the total return for liquid sovereign debt in emerging markets.

Data: This is a study of two typical emerging countries: Turkey and Brazil over the 2000Q1-2011Q4 period.

Methods: The determinants of the sovereign bond index are estimated by three macroeconomic factors: the current account, the external debt and international reserves representing the macroeconomic state of the country, the government solvency and the government liquidity. We use the nonliear autoregressive distributed lag (NARDL) estimator as introduced by Shin et al. (2014) and derived from the seminal work by Pesaran et al. (2001). This methodology allows to estimate the asymmetric long-run and short-run relationships. In particular, we use the positive and negative partial sum decomposition of the current account to determine the asymmetric effects on the sovereign bond index.

Results: Our findings can be summarized as follows: i, An asymmetric long-run relationship exists between the sovereign bond index and the explanatory variables for the following models. Only the long-run effect is asymmetric for Turkey while both short-run and long-run effects are asymmetric for Brazil. ii, The positive and negative shocks on the current account are more significant than a shock on international reserves to reduce the sovereign default risk for Turkey. iii, A negative shock on the current account is stronger than a positive one for Brazil.