2007) “Foreign participation in local-currency bond markets

Abstract: We analyze the development of, and foreign participation in, 49 local bond markets. Countries with stable inflation rates and strong creditor rights have more developed local bond markets and rely less on foreign-currency-denominated bonds. Less developed bond markets have returns characterized by high variance and negative skewness, factors eschewed by U.S. investors. Results based on a three-moment CAPM indicate, however, that it is diversifiable idiosyncratic risk that U.S. investors appear to shun. Taken as a whole our results hint at a virtuous cycle of bond market development. Creditor friendly policies and laws can spark local bond market development and result in lower variance and more right-skewed returns, characteristics that attract foreign participation. In turn, the ability to borrow internationally in the local currency helps avoid th