Nicola Borri (LUISS)

"Limited Participation and Local Currency Sovereign Debt"

30 May 2018, 12:00 pm


Emerging country governments increasingly issue bonds denominated in local currency and the share of this market held by foreign investors, once negligible, has been progressively growing. This paper presents a model of segmented markets, in which specialized foreign investors can access multiple local markets only after paying an entry cost. In the model, risk aversion of foreign investors is counter-cyclical and tied to U.S. short-term interest rate. We show that when foreign investors' risk aversion is sufficiently low, the benefits from investing in these new markets are greater than the entry costs. When we feed actual U.S. interest rate data after the Great Recession, the model predicts a strong increase in the fraction of local currency debt held by foreign investors.