Are Markets Learning? Behavior in the Secondary Market for Brady Bonds

Are Markets Learning? Behavior in the Secondary Market for Brady Bonds

Author: 
Barbone, Luca
Place: 
Washington, D. C.
Publisher: 
World Bank Group
Date published: 
1999
Record type: 
Responsibility: 
Forni, Lorenz, jt. author
Abstract: 

Traders' behavior in assessing the sovereign risk of Brady countries is not constant over time - and it responds especially to market uncertainty. Herd behavior increases with risk, leading (in a volatile environment) to even more volatility. Over time, however, as traders' experience and information stock grows, risk premia may become less volatile. Barbone and Forni analyze some aspects of the market for Brady bonds (restructured debt in developing countries). They focus on how the debt crisis in Mexico in 1994 affected risk assessment (as measured by the stripped spread) in other Brady countries, especially Poland. Their main findings: ° The risk premium (in a single country) has a behavior (one unit root), consistent with the hypothesis that it reflects new market information. ° Among stripped yields, co-movements of sovereign risk premia were stronger during the period of highest volatility in the Mexican crisis. In the case study of Mexico and Poland, they do not reject cointegration for the period July 1994-July 1995; they do reject it for July 1995-July 1996. ° The crisis had a strong permanent effect on risk assessment in Mexico (about 550 basis points). ° Different Brady bonds responded differently to the Mexican crisis. Countries with similar pre-crisis means and volatility reacted similarly (in terms of absolute deviation and the degree of co-movement with the Mexican bonds). Other factors (region, oil producers, date of Brady deal) did not explain observed patterns. ° There was convergence of volatility during the highly volatile period of the Mexican crisis. These results suggest that traders' behavior in assessing the sovereign risk of Brady countries is not constant over time, and responds especially to the level of market uncertainty. Herd behavior increases with risk, leading (in a volatile environment) to even more volati...

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CITATION: Barbone, Luca. Are Markets Learning? Behavior in the Secondary Market for Brady Bonds . Washington, D. C. : World Bank Group , 1999. - Available at: http://library.au.int/are-markets-learning-behavior-secondary-market-brady-bonds