Global (exogenous) factors are increasingly seen as key determinants of the borrowing costs of emerging economies, and for good reason. In principle, the pricing of debt issued by financially integrated emerging economies should be no different from the pricing of non-investment grade securities in general, and low-grade bonds in developed economies in particular. Both should reflect the level of risk of the security, and a risk premium (the price of risk) that is, in turn, a reflection of the risk aversion—or alternatively, risk appetite—of international investors.
It follows that variation in emerging market spreads may be driven by exogenous changes in global risk appetite. In addition, global liquidity influences the international cost of capital and, to the extent that this cost affects debt sustainability, also emerging market spreads. It follows that an important part of the variability of emerging spreads could be seen as a reflection of exogenous factors (such as the international business cycle) that simultaneously determine both risk appetite and the interest rate.
This paper examines this premise empirically. Specifically, it studies the extent to which changes in interest rates and bond spreads in developed countries explain the variability of emerging market spreads in recent years. More precisely, based on high frequency (daily, weekly and monthly) data, it estimates panel error-correction models of emerging spreads on high-yield spreads and international rates, controlling for country-specific variability (using credit ratings as a proxy for country-specific risk or, alternatively, country-month dummies) as well as for the presence of contagion.
