WHAT EXPLAINS CHANGING SPREADSON EMERGING-MARKET DEBT:FUNDAMENTALS OR MARKET

SENTIMENT?

Barry EichengreenAshoka Mody

Working Paper 6408

NBER WORKING PAPER SERIES

WHAT EXPLAINS CHANGING SPREADSON EMERGING-MARKET DEBT:FUNDAMENTALS OR MARKET

SENTIMENT?

Barry EichengreenAshoka Mody

Working Paper 6408http://www.nber.org/papers/w6408

NATIONAL BUREAU OF ECONOMIC RESEARCH1050 Massachusetts Avenue

Cambridge, MA 02138February 1998

The authors are grateful to Steve Dunaway and Anne Jensen of the International Monetary Fund whokindly provided the data, to Ananda Chanda for sterling research assistance, and to Richard Parry forarranging an early informal discussion of the results at the International Finance Corporation. NinaShapiro provided many comments throughout the writing of the paper. The views expressed hereare those of the authors and should not be attributed to the International Monetary Fund, the WorldBank or to the National Bureau of Economic Research.

© 1998 by Barry Eichengreen and Ashoka Mody. All rights reserved. Short sections of text, not toexceed two paragraphs, may be quoted without explicit permission provided that full credit, including© notice, is given to the source.

What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?Barry Eichengreen and Ashoka ModyNBER Working Paper No. 6408February 1998JEL No. F3

ABSTRACT

In this paper we analyze data on nearly 1,000 developing-country bonds issued in the years

1991-96, a period that spans the recent episode of heavy reliance on bonded debt. We analyze both

the issue decision of debtors and the pricing decision of investors, minimizing selectivity bias by

treating the two issues jointly. Overall, the results confirm that higher credit quality translates into

a higher probability of issue and a lower spread. Importantly, however, we find that observed

changes in fundamentals explain only a fraction of the spread compression in the period leading up

to the recent crisis in emerging markets.

Barry Eichengreen Ashoka ModyResearch Department Project Finance and GuaranteesInternational Monetary Fund The World Bank700 19th Street, NW 1818 H Street, NWWashington, DC 20431 Washington, DC 20433and NBER modya@wharton.upenn.edubeichengreen@imf.org