Binary interest rate sensitivities of emerging market corporate bonds

Abstract

We develop a framework to assess interest rate sensitivities of emerging market corporate debt. Our analysis, based on yield indexes, is applied to investment grade and high yield portfolios. We reach beyond correlation-based analyses of interest rate sensitivity and keep our scope centered at capital gains of emerging market corporates and U.S. government bonds portfolios. Our empirical analysis spans over the period [2002][2003][2004][2005][2006][2007][2008][2009][2010][2011][2012][2013][2014][2015]. We address interest rate sensitivity of assets during the ignition, apogee, and the aftermath of the global financial crisis. Based on historical data series, we evidence that the emerging market corporate bonds exhibit two different regimes of sensitivity to interest rate changes. We observe switching from a positive sensitivity under the normal market conditions to a negative one during distressed phases of business cycles and provide economical explanations of such phenomena. We show that emerging market corporate bonds, which on average could appear rather insensitive to the interest rate risk, in fact, present binary interest rate sensitivities. This research sheds light on how financial institutions may approach interest rate risk management including the downside risk hedge. Our findings allow banks and financial institutions to optimize economic capital under Basel III regulatory capital rules.

Capital Gains Sensitivity of US BBB-Rated Debt to US Treasury Market: Markov-Switching Analyses

“…During normal economic conditions, the average sensitivity is positive, while during the crisis, it is negative and amplified. We clearly observe the time-varying behavior of capital gains sensitivity over each phase, similar to [9,11]. e plot shows that sensitivity is mostly positive before 2007 and after 2011, while it turns negative between that time interval.…”

“…Our methodology is based on [11], but the focus is on the US market rather than emerging economies. e average price of each portfolio can be calculated by discounting future cash flows of coupons and principals.…”

“…A simple metric of the sensitivity of capital gains rather than the sensitivity of credit spread to risk-free interest rates has been proposed to study the interest rate sensitivity of US corporate debt [9], emerging market sovereign bonds [10], and emerging market corporate fixed-income securities [11].…”

Rethinking economic capital management through the integrated derivative-based treatment of interest rate and credit risk

“…In our more recent work, Gubareva and Borges (2016b), following a different, non-derivative, bond yield-based approach we demonstrate the binary IR sensitivity of EM corporate bonds. Thus, further research on the behavior of the IR sensitivity of sovereign debt is highly desirable.…”

Emerging markets financial sector debt: A Markov‐switching study of interest rate sensitivity

“…In this context, the interest rate sensitivity of assets, interest rate risk management and downside risk management have naturally received much attention from financial sector players and academics. The interest rate (IR) sensitivity literature includes studies on, for example, the sensitivity of corporate bond yield spreads to changes in the yield curve (Boulkeroua & Stark, 2013), interest rate and credit spread dynamics (Neal, Rolph, Dupoyet, & Jiang, 2015), the flight‐to‐quality and spread changes (Gubareva & Borges, 2016a), the relationship between interest rates and credit spreads (Dupoyet, Jiang, & Zhang, 2018), the determinants of bond risk premia (Bauer & Hamilton, 2018) and integrated interest rate and credit risk management (Gubareva, 2018; Gubareva & Borges, 2017, 2018a, 2018b, 2019, among others).…”