Exchange Rate Risk and Local Currency Sovereign Bond Yields in Emerging Markets
31 Pages Posted: 7 Jan 2015
Date Written: December 2014
In this paper we consider the role of exchange rate risk in influencing local currency sovereign bond yields in emerging market economies (EMEs). We explicitly account for exchange rate expectations and uncertainty around them, as measured by exchange rate volatility. The analysis points to an important influence of exchange rate risk: when exchange rate volatility increases, investors require a larger yield compensation for holding EME local currency sovereign bonds. The impact of exchange rate volatility has become more important since May 2013, when investors realised that the Federal Reserve may reduce the scale of its asset purchases sooner than previously expected.
Keywords: emerging markets, exchange rate risk, local currency sovereign bond yields
JEL Classification: E43, E44
Suggested Citation: Suggested Citation