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Expected risk and excess returns predictability in emerging bond markets

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  • Chih-Ling Lin
  • Ming-Chieh Wang
  • Yin-Feng Gau

Abstract

This study examines the predictability of expected excess returns from eight emerging bond markets within an international asset pricing framework. Two sets of instruments are used, which include both world and local factors, to forecast emerging bond returns. Besides investigating the influence of the macroeconomic factors in specific countries on bond returns in those countries, this study also divides local factors into macroeconomic and financial factors. Unlike previous studies, we apply macroeconomic instruments that contain more information on excess returns as a proxy for local risk factors via principal component analysis methodology. The information variable approach enables the prediction of excess bond returns based on world and local factors and facilitating understanding of the degree of integration between emerging bond markets and developed bond markets. The results indicate that the bond market in emerging world is partially integrated to that in the developed world and the predictability of local factors that include both financial and macroeconomic information variables can forecast around 25-66% of the returns of emerging bonds. Incorporating the macroeconomic variables increases the explanatory power of the model. Both world and country-specific local instruments can forecast excess bond returns, but local instruments appear to be better predictors of such returns, particularly the local credit spread to US. Additionally, this study finds that investor risk aversion is significant among most of sample countries.

Suggested Citation

  • Chih-Ling Lin & Ming-Chieh Wang & Yin-Feng Gau, 2007. "Expected risk and excess returns predictability in emerging bond markets," Applied Economics, Taylor & Francis Journals, vol. 39(12), pages 1511-1529.
    • Handle: RePEc:taf:applec:v:39:y:2007:i:12:p:1511-1529
    DOI: 10.1080/00036840600606336
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    Cited by:

    1. Amir Saadaoui & Younes Boujelbene, 2016. "Volatility Transmission between Dow Jones Stock Index and Emerging Bond Index," EuroEconomica, Danubius University of Galati, issue 2(12), pages 194-216, April.
    2. Mensi, Walid & Hammoudeh, Shawkat & Reboredo, Juan Carlos & Nguyen, Duc Khuong, 2014. "Do global factors impact BRICS stock markets? A quantile regression approach," Emerging Markets Review, Elsevier, vol. 19(C), pages 1-17.
    3. Bedri Kamil Onur Tas, 2011. "Private information of the Fed and predictability of stock returns," Applied Economics, Taylor & Francis Journals, vol. 43(19), pages 2381-2398.
    4. Amir Saadaoui & Younes Boujelbene, 2016. "Volatility Transmission between Dow Jones Stock Index and Emerging Bond Index," Acta Universitatis Danubius. OEconomica, Danubius University of Galati, issue 12(2), pages 194-216, April.
    5. Ricardo Sousa, 2011. "Building proxies that capture time-variation in expected returns using a VAR approach," Applied Financial Economics, Taylor & Francis Journals, vol. 21(3), pages 147-163.
    6. Yin-Feng Gau & Wen-Ju Liao, 2012. "The predictability of excess returns in the emerging bond markets," Applied Financial Economics, Taylor & Francis Journals, vol. 22(17), pages 1429-1451, September.
    7. Liu, Tengdong & Hammoudeh, Shawkat & Thompson, Mark A., 2013. "A momentum threshold model of stock prices and country risk ratings: Evidence from BRICS countries," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 27(C), pages 99-112.

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