COMOVEMENTS IN EMERGING MARKET BOND RETURNS: AN EMPIRICAL ASSESSMENT

The objective of the paper is to empirically assess the comovement of emerging bond returns of the key constituent countries of the EMBI Global benchmark Index since their introduction (broadly in 1997) up to the present. We aim at disentangling the respective roles of common external factors and "pure" contagion in the recent events of market spillovers. The unweighted average of cross-country rolling correlation coefficients, adjusted and unadjusted for the presence of common external factors, provides a first assessment of the joint behavior of emerging markets bond returns during the sample period. We furthermore show that the cross-country average correlations method may not be useful in summarizing market results if the underlying distribution of bond returns is not unimodal (i.e., if there are underlying groups that exhibit high within-group comovement but not between-group comovement). Several methods are used on a year-to-year basis in order to identify periods where the “two-tier paradigm” of emerging markets prevails. The analysis of correlation matrices enables us to identify groups of countries moving together during the recent events in emerging markets. These findings are further refined by performing Principal Component and Cluster Analysis. We provide a method in order to quantify the excess comovement common to all emerging countries as well as the country-specific one. Finally, we find evidence of “market tiering” and investors' discrimination especially during tranquil times: the first three quarters of 1997, from the third quarter of 1999 to the end of 2000 and from 2003 to 2005. We suggest that regional patterns and credit quality differentiation have an important role to play in the investors' discriminating behavior regarding the emerging bond markets whenever the period is free of strong and unforeseen shocks leading to spillover across countries and markets.