Cristián Cuevas, Universidad de Los Andes

Paper: “Safe Assets in Emerging Market Economies”

Abstract: “Do local-currency sovereign bonds in emerging markets work as safe assets? I estimate convenience yields arising from their safety/liquidity both from the perspective of a global and a domestic investor. In a sample of 9 middle-income EMEs, I find a large convenience yield robust to both measures. I characterize the dynamics of this premium along the local and global financial cycle. The main difference relative to the convenience yields of U.S. Treasuries is not only their smaller magnitude but also that the global investor’s convenience yield drops during episodes of high global risk aversion. I analyze two exogenous shocks to EMEs (the Taper Tantrum and Covid-19) and find that the drop in the convenience yield is not explained by the increase in credit risk or the risk premium but by a switch in investors’ preferences towards a global safe asset. Results are consistent with a model of a small open economy facing endogenous borrowing constraints and where a foreign and a local sovereign bond serve as collateral (although with different qualities) and thus carry a convenience yield. I use the model to show that shocks to demand for safety have different effects on macroeconomic variables than the standard interest rate or risk premium shocks.”