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Title

International Bond Portfolio: Evidence from Emerging Markets

Creator

Wang, Jinghua

Date

2012-08-20, 2012-07

Description

Allocating capital to fixed income instruments issued by emerging markets (EMs), governments may provide significant benefits to both the...
Show moreAllocating capital to fixed income instruments issued by emerging markets (EMs), governments may provide significant benefits to both the investors and issuers of these instruments. For investors, emerging market instruments may offer a significant risk premium relative to conventional investments in developed markets (DMs) bonds. Furthermore, EMs bonds offer potential diversification benefits because these bonds are not strongly correlated with DMs instruments. For emerging market government issuers, access to global fixed income markets is likely to improve liquidity and offer lower borrowing costs relative to a strategy focused purely on the domestic market. Access to global capital provides these governments with the opportunity to invest in infrastructure projects that promote economic growth and development. Over the past fifty years, economic growth in emerging markets has been supported by investments in capital and technology from the developed world. The benefit of this development for the emerging markets, as measured by growth in income, employment, and wealth, is immediately apparent. There have also been significant advantages for the developed world through opportunities for higher risk adjusted returns from investments in emerging markets. For the most part, the benefits of diversification into emerging markets have focused on equity markets. In this dissertation, the focus is on investments in fixed income instruments. Specifically, the dissertation explores the performance benefits of DMs combined with EMs. It first identifies the potential diversification and describes the financial integration for incorporating EMs bonds into DMs government bond portfolios. In the second phase, it constructs the dynamic linear regression models and conducts the mean-variance tests to demonstrate the incremental benefit of the strategy. In the last phase, a robust test examines the strength of bond portfolio performance between DMs with EMs and the U.S. 7-10 year government bond index. The empirical analysis in this dissertation focuses on three DMs sources of bonds and four EMs regions. Since the EMs are evolving rapidly, and since the global financial markets have also been subject to erratic fluctuations during the global financial crisis, the empirical models employed in the dissertation do not rely on stationarity assumptions. Instead, Kalman Filter (KF) procedures are employed that generate the time-varying coefficients in the multi-factor models in response to new conditions in the markets. The outputs from the KF are used as inputs in the factor model, and the outputs from the factor models are used as inputs in a Markowitz style mean-variance optimization model. This study explores the benefits of the diversification of global government bond portfolio, and provides complete performance evaluations of DMs with or without EMs. The study examines: i) the benefits of inclusion of EMs bonds in DMs; ii) the degrees of financial integration among the research markets; iii) the correlation of the macro-economic factors in the multi-factor models; iv) the relative bond returns of dynamic factor models with time-varying coefficients; and v) the robust tests of bond portfolio performance between DMs with EMs and bond index. The results of this study provide important implications for global investors by identifying diversification gains in EMs.
Ph.D. in Management Science in Finance, July 2012
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