Cost of sovereign debt and foreign bias in bond allocations

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Abstract

Finance theory suggests that markets where foreign bond portfolio investors overweight their portfolio relative to the prescribed theoretical benchmark should experience higher international risk sharing. Correspondingly, the cost of debt in such markets should be lower compared to markets facing a lower degree of international risk sharing. We empirically examine this prediction using a panel data set of sovereign bond yield spreads and a measure of suboptimal foreign bond portfolio allocations for 50 emerging and ten developed markets. Consistent with theory, our results show higher levels of foreign bond allocations – relative to the theoretical benchmark – are negatively related to the cost of debt. These results have important policy implications as a country’s cost of debt could potentially be lowered by encouraging foreign portfolio investors to hold their optimal allocation.
Original languageEnglish
Pages (from-to)75-91
Number of pages27
JournalJournal of International Financial Markets Institutions and Money
Volume51
Early online date13 Sep 2017
DOIs
Publication statusPublished - 1 Nov 2017

Keywords

  • cost of debt
  • international risk sharing
  • foreign bias
  • Eurozone sovereign debt crisis
  • natural experiment

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