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

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  • Ho, Edmund Ho Cheung

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.

Suggested Citation

  • Ho, Edmund Ho Cheung, 2022. "Foreign participation in local currency government bond markets in emerging Asia: Benefits and pitfalls to market stability," Journal of International Money and Finance, Elsevier, vol. 128(C).
    • Handle: RePEc:eee:jimfin:v:128:y:2022:i:c:s0261560622001024
    DOI: 10.1016/j.jimonfin.2022.102699
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    2. Guilherme Suedekum, 2023. "Local Currency Sovereign Debt Markets, Global Financial Conditions and the Role of Foreign Investors," IHEID Working Papers 19-2023, Economics Section, The Graduate Institute of International Studies.

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    More about this item

    Keywords

    Foreign holdings; Emerging markets; Local currency government bond; Yield spread; Exchange rate risk;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models

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