“How ETFs Amplify the Global Financial Cycle in Emerging Markets”, with Nathan Converse and Eduardo Levy Yeyati, Review of Financial Studies, vol. 36 (9), pp.3423-3462.
Lead Article. Featured in Voxeu, and Seeking Alpha.
Since the early 2000s exchange-traded funds (ETFs) have grown to become an important investment vehicle worldwide. In this paper, we study how their growth affects the sensitivity of international capital flows to the global financial cycle. We combine comprehensive micro-level data on investor flows with a novel identification strategy that controls for unobservable time-varying economic conditions at the investment destination. For the emerging market universe, we find that the sensitivity of investor flows to global risk factors for equity (bond) ETFs is 2.5 (2.25) times higher than for equity (bond) mutual funds. In turn, we show that countries where ETFs hold a larger share of financial assets are significantly more sensitive to global risk factors, both in terms of total equity flows and prices. We conclude that the growing participation of ETFs amplifies the incidence of the global financial cycle in emerging markets.
“Large International Corporate Bonds: Investor Behavior and Firm Responses”, with Charles Calomiris, Mauricio Larrain and Sergio Schmukler, Journal of International Economics, vol. 137.
Featured in the NBER Digest, and The Financial Times.
Since 2008, emerging market corporations increased their borrowing in international debt markets, while their economies received large capital inflows. We show that their borrowing happened in a particular segment of the market. Firms significantly increased their large bond issuances, mostly above US$500 million, which were cheaper to issue. Moreover, we find a strong clustering of issuances with face value of exactly $500 million after 2008 compared to developed markets. This suggests increased willingness from investors, especially cross-over investors, to purchase emerging market bonds included in newly created bond indexes, which require a minimum face value of $500 million. However, not all firms could issue such large bonds. Firms large enough to do so faced a tradeoff. Issuing index-eligible bonds allowed them to borrow at a lower cost at the expense of accumulating cash. Because of this “size yield discount,” many companies increased their issuances of index-eligible bonds, accumulating cash holdings.
We study the transmission of sovereign debt inflow shocks on domestic firms. We exploit episodes of large sovereign debt inflows in six emerging countries that are due to the announcements of these countries’ inclusion in two major local currency sovereign debt indexes. We show that these episodes significantly reduce government bond yields and appreciate the domestic currency and have heterogeneous stock market effects on domestic firms. Firms operating in tradable industries experience lower abnormal returns than firms in non-tradable industries. In addition, financial, government-related, and firms which rely more on external financing experience relatively higher abnormal returns. The effect on financial and government-related firms is stronger in countries that display larger reductions in government bond yields. The effect on tradable firms is stronger in countries where the domestic currency appreciates more. We provide a stylized model that rationalizes these results. Our findings shed novel light on the channels through which sovereign debt inflows affect firms in emerging economies.
“Real Effects of Sovereign Debt Inflow Shocks”, with Lorenzo Pandolfi, 2020, AEA Papers and Proceedings.
This paper analyzes the real effects on firms of sovereign debt inflow shocks in emerging countries. We follow Broner, Martin, Pandolfi and Williams (2020), and exploit six episodes of country inclusions into two major local currency sovereign debt indexes. We complement their evidence by analyzing real variables and find that government-related and financial firms experience larger growth in income, employment, and dividends, relative to tradable firms, in the three years following sovereign debt inflow shocks. Our findings suggest that capital inflows to sovereign debt markets can hamper exports and benefit financial and service-based firms, thus reshaping the domestic economy.
“Capital Flows and Sovereign Debt Markets: Evidence from Index Rebalancings”, with Lorenzo Pandolfi, 2019, Journal of Financial Economics, vol. 132 (2), pp. 384-403. [Ungated WP Version]
In this paper we analyze how government bond prices and liquidity are affected by capital flows to the sovereign debt market. Additionally, we explore whether these flows spill over to the exchange rate market. To tackle endogeneity concerns, we construct a measure of informationfree capital flows implied by mechanical rebalancings (FIR) from the largest local-currency government-debt index for emerging countries. We find that FIR is positively associated with the returns on government bonds and with the depth of the sovereign debt market in the aftermath of the rebalancings. These capital flows also impact on the exchange rate market: larger inflows (outflows) are associated to larger currency appreciations (depreciations).
“Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market”, 2018, Review of Financial Studies, vol. 31 (12), pp. 4958-4994. [Ungated WP Version]
Featured in All About Finance and La Republica.
This paper uses a natural experiment to show that government access to foreign credit increases private access to credit. I identify a sudden, unanticipated, and arguably exogenous increase in capital inflows to the sovereign debt market in Colombia. This was due to J.P. Morgan’s inclusion of Colombian bonds into its emerging markets local currency government debt index, which led to an increase in the share of sovereign debt held by foreigners from 8.5 to 19 percent. This event had significant and heterogeneous effects on Colombia’s commercial banks: banks that acted as market makers in the treasury market reduced their sovereign debt holdings by 7.8 percentage points of assets and increased their commercial credit availability by 4.2 percentage points of assets compared to the rest of the banks. The differential increase in credit was around 2 percent of GDP. Industry level evidence suggests that this had positive effects on the real economy. A higher exposure to market makers led to a higher growth in employment, production, sales and GDP.
“International Asset Allocations and Capital Flows: The Benchmark Effect”, with Claudio Raddatz and Sergio Schmukler, 2017, Journal of International Economics, vol. 108, pp.413-430. [Ungated WP Version]
Featured in All About Finance, The Financial Times, The Institute for International Economic Policy Blog, Voxeu, WB Research Highlights, WB Research Newsletter.
Benchmark indexes have become important in financial markets for portfolio investment. In this paper, we study how international equity and bond market indexes impact asset allocations, capital flows, asset prices, and exchange rates across countries. We use unique monthly micro-level data of benchmark compositions and mutual fund investments during 1996–2014. We find that movements in benchmarks appear to have important effects on equity and bond mutual fund portfolio allocations, including passive and active funds. The effects persist after controlling for time-varying industry-level factors, country-specific effects, and macroeconomic fundamentals. Changes in benchmarks not only impact asset allocations, but also capital flows, abnormal returns in aggregate stock and bond prices, and exchange rates. These systemic effects occur not just when benchmark changes are announced, but also later, when they become effective. By impacting country allocations, benchmarks explain apparently counterintuitive movements in capital flows and asset prices, as well as contagion effects.
“Financial Globalization in Emerging Economies: Much Ado About Nothing?”, with Eduardo Levy Yeyati, 2014, Economia, vol. 14 (20), pp. 91-131.
Featured in Voxeu.
Financial globalization (FG), understood as the deepening of cross-border capital flows and asset holdings, has become increasingly relevant for the developing world for a number of reasons, including the consequences of its changing composition on countries’ balance sheets, its role in the transmission of global financial shocks, its benefits in terms of financial development, international risk, and business cycle smoothing, and the implication of all of the above for macroeconomic and prudential policies. In this paper, we focus on these issues from an empirical perspective, building on, updating, and refocusing the existing literature to characterize the evolution and implications of financial globalization in emerging economies.
“Emerging Economies in the 2000s: Real Decoupling and Financial Recoupling”, with Eduardo Levy Yeyati, 2012, Journal of International Money and Finance, vol. 31 (8), pp. 2102-2126. [Ungated WP Version]
Featured in Voxeu.
The paper documents an intriguing development in the emerging world in the 2000s: a decoupling from the business cycle of advanced countries, combined with the strengthening of the co-movements in the main emerging market assets that predates the synchronized selloff during the crisis. In addition, the paper tests the hypothesis that financial globalization, to the extent that it creates a common, global investor base for EM, could lead to a tighter asset correlation despite the weaker economic ties. While an examination of the impact of alternative financial globalization proxies yield no conclusive result, a closer look at global emerging market equity and bond funds show that the latter indeed foster financial recoupling during downturns, reflecting the fact that they trade near their respective benchmarks and respond to withdrawals by liquidating holdings across the board.