Emerging markets spread

The amount of data available for building emerging market spread factors is unfortunately scarce. First, there are often at best only a few bonds issued by sovereign issuers in emerging markets. The second problem is that there are mostly US dollar-denominated. Even when some bonds denominated in, say, euro are available, there is generally little returns history. In some cases, we will seek risk forecasts for an... 

Emerging market spread volatilities are shown in Exhibit 23.10. The spread risk of Latin American obligors tend to be above average, currently largest for Argentinean and Brazilian markets that have a spread risk comparable to a B to CCC rated euro corporate. The risk of Asian issuers is on the other hand below average and comparable to the interest rate observed in developed markets. We clearly observe a wide spectrum of risk characteristics that confirms the need to build a separate factor for each market. 

DCHIBIT 23.10 Emerging Market Spread Volatilities as of 30 November 2002... 

Unfortunately, we cannot stop there and use equation (23.11). The benefit of using global factors is that they help compute cross-market terms and constitute the skeleton of the matrix. The drawback is a loss of resolution at the local level. A solution to this problem is to replace local blocks by a local covariance matrix computed using the full set of original local factors. Off-diagonal blocks need to be adjusted in the process to insure that the final matrix is positive definite. A more detailed discussion of how the local covariance blocks are replaced can be found in Stefek. Local covariance blocks can be computed individually for each market, but also for emerging markets spread factors and currency factors. As a result, shorter half-life can be used for return series that are typically more volatile, such as currency and emerging market returns. 

EXHBIT 23.9 ExampI es of Spread Returns for Two Emerging Markets... 

Credit default swaps can be used to trade credit spreads. Say investors believe the credit spread between certain emerging-market government bonds and U.S. Treasuries is going to widen. The simplest way to exploit... 

This section discusses the factors that must be assessed in analyzing the relative values of government bonds. Since these securities involve no credit risk (unless they are emerging-market debt), credit spreads are not among the considerations. The zero-coupon yield curve provides the framework for all the analyses explored. 

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