“Global Investors in Local-Currency Bond Markets: Implications for Bond Yields and Exchange Rates”, with Pierre De Leo, Lorena Keller, Giuliano Simoncelli, and Mauricio Villamizar Villegas.
In emerging economies—unlike in advanced ones—higher bond term premia are typically associated with higher currency premia. We attribute this pattern to the prevalence of global investors in local-currency bond markets. Using transaction-level data from Colombia’s bond and foreign exchange markets, we document that any foreign investors’ bond transaction is simultaneously associated with a corresponding transaction in the spot foreign exchange market. We incorporate these correlated flows into a portfolio-balance model alongside short-term interest rate risk. The model explains the comovement in bond yields and exchange rates, the patterns of positions and returns in bond and foreign exchange markets, the effects of quantitative easing and foreign exchange interventions, and their differences between advanced and emerging economies.
“Inelastic Demand Meets Optimal Supply of Risky Sovereign Bonds”, with Matias Moretti, Lorenzo Pandolfi, Sergio Schmukler, and German Villegas-Bauer.
We study how investor demand influences government borrowing capacity, default risk, and bond prices. We develop a sovereign debt model with a rich demand structure, featuring investors with asset-allocation mandates. In our framework, bond prices depend not only on government policies and default risk, but also on investor composition and demand elasticity. We estimate this elasticity from bond price responses to the periodic rebalancing of a major emerging markets bond index, which shifts investors’ allocations. We calibrate the model using this estimate and show that a downward-sloping demand acts as a disciplining device that mitigates debt dilution by curbing future issuance. This market-based mechanism lowers default risk and allows the government to sustain higher debt. Unlike standard models, where discipline arises from default penalties, our mechanism operates through investor behavior. This distinction matters for policy: with market discipline in place, fiscal rules have milder effects on borrowing and default risk.
“The Anatomy of Index Rebalancings: Evidence from Transaction Data”, with Mariana Escobar, Lorenzo Pandolfi, and Alvaro Pedraza.
We exploit a novel dataset covering the universe of transactions in the Colombian Stock Exchange to analyze episodes of additions to and deletions from MSCI equity indexes. We find additions and deletions to have large price effects: the median cumulative abnormal return in absolute value is 5.5%. We show that these price effects are due to large demand shocks by different classes of international investors – not only passive funds and ETFs, but also active mutual funds, pension funds and government funds – which are not absorbed by arbitrageurs. Consistent with recent asset pricing models with limits to arbitrage, we estimate stock demand curves to be very inelastic: the demand elasticity for the median stock in our sample is -0.34, implying that a 1% increase in the demand for the stock increases its price by 2.9%.
“Drug Money and Bank Lending: The Unintended Consequences of Anti-Money Laundering Policies”, with Pablo Slutzky and Mauricio Villamizar-Villegas.
We explore the unintended consequences of anti-money laundering (AML) policies. For identification, we exploit the implementation of the SARLAFT system in Colombia in 2008, aimed at controlling the flow of money from drug trafficking into the financial system. We find that bank deposits in municipalities with high drug trafficking activity decline after the implementation of the new AML policy. More importantly, this negative liquidity shock has consequences for credit in municipalities with little or nil drug trafficking. Banks that source their deposits from areas with high drug trafficking activity cut lending relative to banks that source their deposits from other areas. We show that this credit shortfall negatively impacted the real economy. Using a proprietary database containing data on bank-firm credit relationships, we show that small firms that rely on credit from affected banks experience a negative shock to investment, sales, size, and profitability. Additionally, we observe a reduction in employment in small firms. Our results suggest that the implementation of the AML policy had a negative effect on the real economy.