Abstract

Do local-currency sovereign bonds in emerging markets work as safe assets? I estimate con- venience 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 finan- cial cycle. The main difference relative to the convenience yields of U.S. Treasuries is 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.

JEL Codes: E43, F30, G12.
Keywords: convenience yields, sovereign bonds, emerging markets.