Applying multivariate-fractionally integrated volatility analysis on emerging market bond portfolios
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Financial Innovation
RESEARCH
Open Access
Applying multivariate-fractionally integrated volatility analysis on emerging market bond portfolios Mustafa Demirel1,2 and Gazanfer Unal3* * Correspondence: gazanferunal@ gmail.com 3 Administrative Sciences, Bahcesehir University, 34349 Istanbul, Turkey Full list of author information is available at the end of the article
Abstract This study examines emerging market (EM) local bonds from a portfolio risk perspective and suggests methodologies for risk evaluation, on which the literature is limited. Despite the growth of EM bond funds in recent years, comprehensive studies regarding this industry have been scarce. In light of this, 203 different local bonds of EM countries—Indonesia, Brazil, India, South Africa, Mexico, and Turkey— are elaborated in terms of return, volatility, and cross-correlation features. This study focuses on an untouched field—long memory properties—and the application of fractional models to EM bond portfolios. Based on the outcomes of a dynamic conditional correlation and fractionally integrated generalized autoregressive conditional heteroscedasticity approach and related value at risk analysis, the study finds that fractional models are useful tools for risk management, as they deliver satisfactory empirical results for several static and dynamic versions of EM bond portfolios.
Introduction and literature review In the last decade, surging capital flows to emerging market (EM) bonds and the popularity of EM funds have made research in this field valuable. In recent years, due to extraordinary shifts in the monetary policies of developed market (DM) and countryspecific macroeconomic developments, EM currencies and interest rates have fluctuated sharply. Although the composition of EM bond funds is heterogeneous because the countries involved have different economic and market structures, these countries’ asset prices are correlated to each other. Unhedged bond portfolios that are affected by both currencies and interest rates have suffered, and having an effective risk management strategy has become more critical. The literature on risk analysis of EM fixed income has been limited and scattered. Early research mostly focused on the risk–reward profile and showed the diversification benefits of EM bonds, along with other asset classes (Burik and Ennis 1990, Erb et al. 1999, etc.). Similarly, research on systemic risk, risk transmission, or financial network touched on EM bonds as part of the whole investment universe (see Kou © The Author(s). 2020 Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article's Creative Commons licence, unless indicated otherwise in a
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