What might segment and integrate sovereign bond markets?
Investment barriers are not burdensome in major developed markets during quiet times, but they may be prohibitive in markets that are not well developed, are undergoing a financial/currency/political crisis, or have defaulted in the recent past. These markets’ bonds may be more prone to fire-sale risk, and investors might therefore abstain from investing in the public bonds of such markets. The reluctance of foreign investors to buy sovereign bonds issued by Greece and Argentina has been well documented. And during the eurozone crisis, bonds from peripheral countries were mainly bought by local investors (banks). The widespread practice of banks holding local government debt—often encouraged by financial regulation—could prevent market integration.
With regard to sovereign bond market integration: The continued trend of the international liberalization of financial markets, marked by the tremendous increase in the trading of bond funds, closed-end bond funds, and bond ETFs over the last few years has helped integrate international bond markets. Bond funds were the largest segment of the closed-end fund market at the end of 2010. SFI Professors Ines Chaieb and Rajna Gibson Brandon show in their paper that while integration has trended upward for most countries and across maturities, there is substantial dispersion. Sovereign bond market integration in emerging markets is lagging behind that in developed markets. This is not surprising in view of the lack of maturity of the former’s local government bond markets.
Interested to find out more? Read the latest SFI Practitioner Roundup, written by SFI Prof. Ines Chaieb and Rajna Gibson Brandon, and learn more about the dynamics of sovereign bond market integration.