A New Era of International Financial Integration: Global, Market, and Regional Factors

Transcription

1 A New Era of Inernaional Financial Inegraion: Global, Marke, and Regional Facors Marco Cipriani George Washingon Universiy Washingon, DC 252 hp://home.gwu.edu/~mciprian Graciela L. Kaminsky* George Washingon Universiy and NBER Washingon, DC 252 hp://home.gwu.edu/~graciela December 27 Preliminary and Incomplee Absrac This paper analyzes he paern of inernaional financial inegraion by sudying public and privae gross issuance in inernaional bond, equiy, and syndicaed loan markes of one hundred one counries since 198. We develop and esimae a non saionary Bayesian dynamic laen facor model wih one world facor and hree marke facors. The four facors accoun, on average, for abou 5 percen of he variance of flucuaions in inernaional issuance, an indicaion of subsanial financial inegraion. Our resuls also sugges ha Japan, Lain American counries, and he Middle Eas region sand our wih respec o he res of he world economy by exhibiing largely idiosyncraic paerns of issuance. * This paper was in par wrien while Kaminsky was a visiing scholar a he Hong Kong Moneary Auhoriy. Kaminsky hanks his insiuion for is hospialiy. We hank he Cener for Globalizaion a George Washingon Universiy for financial suppor. The views expressed herein are hose of he auhors and no necessarily hose of he Hong Kong Moneary Auhoriy. We also hank Pablo Vega-Garcia for excellen research assisance.

2 I. Inroducion The 199s winessed a dramaic increase in inernaional financial inegraion, wih a variey of measures suggesing ha he exen of globalizaion has even surpassed ha observed during he Gold Sandard Period. Sill, he crises of he lae 199s have fueled concern abou a reversal in his rend. In fac, ne capial inflows dwindle o a rickle in mos of emerging markes in he afermah of he Asian crisis (alhough hey recover in 24). Bu his reversal is no observed in maure economies. Financial inegraion across indusrial counries coninues o surge even afer he financial marke meldown in lae 1998, wih large curren accoun deficis in he Unied Saes being financed, in large par, by surpluses in oher indusrial counries. These paerns in inernaional capial flows sugges he onse of somewha divergen rends in financial inegraion, wih increasing financial linkages in maure economies and lagging inegraion in developing counries. Alernaive measures of financial inegraion, however, ell a differen sory. Ineres rae differenials are no persisen even for emerging economies suggesing sophisicaed inernaional financial linkages. Perhaps, he evidence provided by ne capial inflows presens an incomplee picure of financial inegraion. While zero ne capial inflows may reflec no inernaional financial inegraion, hey may also reflec complee inegraion wih inernaional diversificaion in which inflows are jus offse by ouflows. To have a beer grasp of inegraion, one we would like o have an assessmen of socks of foreign asses and liabiliies. The IMF repors inernaional invesmen posiions of each counry, bu only saring from More sparse daa is available for a dozen indusrial counries saring in he 198s. 1 The daa on indusrial counries indicaes ha inernaional globalizaion akes he form of asse swapping by maure economies raher han developmen flows from rich o poor counries. Unforunaely, he daa for emerging economies is so far unavailable o assess he exen of asse swapping across emerging economies or wih indusrial counries. 2 Even socks of inernaional asses and liabiliies can only provide a parial measure of inegraion and do no necessarily capure which counries have more and frequen access o 1 An imporan source of ne foreign asses for indusrial and developing counries is available in Lane and Milesi- Ferrei (21). 2 Sill, according o Obsfeld and Taylor (22), he degree of diversificaion across emerging economies is much less han ha of indusrial economies and i even seems o be lower han ha during he prewar period, wih gross deb in emerging markes averaging 11 percen of GDP since 198 bu abou 3 percen of GDP during he Gold Sandard period. 1

3 inernaional markes because large borrowings could be offse by equally large repaymens. Marke access can be assessed more clearly by looking a gross issuance. This paper will gauge he exen of financial inegraion by looking a gross issuance of four financial ceners and five regions in hree inernaional markes: bonds, equiies, and syndicaed loans markes from 198 o 24. The four financial ceners are Germany, Japan, Unied Kingdom, and Unied Saes and he five regions are Asia, Lain America, Middle Eas and Africa, Transiion Economies, and Maure Economies. 3 The five regions capure issuance by eighy-five counries: Asia (14), Lain America (23), Middle Eas (2), Transiion Economies (18), and Maure Economies (22). To our knowledge, his is he firs paper o examine issuance in inernaional markes for boh indusrial and developing counries. Previous research was mosly concenraed on explaining he ineres rae spreads a issuance in he inernaional syndicaed loan marke or in he bond marke. 4 In view of he debae on he exen of inernaional financial inegraion around he globe, we would like o capure wheher financial inegraion is a world phenomenon, or i is jus reflecs inegraion in a few regions or group of counries. Since, as i is well known, inernaional financial markes did no ake off simulaneously, i is also imporan o undersand he role of various financial insrumens (bonds, equiies, loans) in he exen of inernaional financial inegraion. To gauge he relaive imporance of hese facors, we esimae a Bayesian dynamic laen facor model wih one global (or world) facor and hree marke facors (one for each marke). The model also allows he esimaion of idiosyncraic shocks o regions and markes. This echnique was developed by Chrisopher Orok and Charles Whieman (1998), who use a Bayesian single dynamic facor model o sudy coinciden and leading economic indicaors. This economeric mehodology was laer exended o a muliple facor seing o examine he exen of comovemen in inernaional business cycles in Kose, Orok and Whieman (23). These papers were concerned wih common flucuaions of saionary series. We have now exended his mehodology o sudy comovemen in non-saionary series. Our resuls indicae ha no all regions paricipae equally in he new era of financial inegraion. Issuance in inernaional financial markes of Japan and Lain America is dominaed by hese wo regions fundamenals. For example, he booms and buss in inernaional issuance 3 Of course, we exclude he four financial ceners from he maure economies group. 4 See, for example, Ashoka Moody and Barry Eichengreen (1998). 2

4 of Lain America in he 199s were more pronounced ha hose observed in inernaional issuance of oher regions. Our resuls also indicae ha issuance in he inernaional equiy marke followed differen dynamics from hose in he bond and syndicaed loan markes. The res of he paper is organized as follows. Secion II examines he daa, Secion III presens a brief hisory of he developmen of he inernaional bond, equiy, and loan markes. Secion IV presens he model. Secion V discusses he model esimaes. Secion VI links counry-specific flucuaions in issuance o idiosyncraic economic fundamenals. Secion VI discusses he conclusions. II. The Daa This paper examines access o inernaional capial markes for boh maure and emerging markes. To do ha, we focus on gross issuance in inernaional bond, equiy, and syndicaedloan markes. The daa we use is obained by Dealogic, who compiles informaion on issuance (a he securiy level) in inernaional bond, equiy, and syndicaed loan markes. The daabase sars in 198 (1983 for equiy issuance) and i covers issuance by over 11 counries. For he bond and he syndicaed loan markes, he daabase includes borrowing by he privae secor and he governmen. We now describe in more deail each of he markes. Bonds The daabase on bond issues sars in 198. Iniially, he daabase only covered inernaional issues. More recenly, Dealogic sared o compile informaion on issuance in domesic markes, bu he daa on domesic issues sill does no cover many counries. The informaion on each issue is quie deailed. For each issue, here is informaion on he amoun of funds raised and he daes of announcemen and mauriy of bond as well as informaion on he name of he issuer, he secor of he immediae borrower (issuer), he secor of he ulimae borrower (paren company of he borrower or guaranor), counry of residence and naionaliy of he issuer. The daabase also provides informaion on he issue ype (fixed rae, floaing rae, zero-coupon bond), he legal jurisdicion under which he bond is issued, and a variey of oher characerisics, such as, wheher he bond reurns are linked o inflaion or oupu, or wheher 3

5 hey are asse-backed. There is also informaion on he raings of individual issues a he ime of issuance. From his daabase we only exrac he informaion on inernaional bonds. Our definiion of inernaional securiies follows ha of he BIS, who classifies bonds as inernaional according o he locaion of he ransacion, he currency of issuance, and he residence of he issuer. According o his classificaion, inernaional issues comprise all foreign currency issues by residens and non-residens in a given counry and all domesic currency issues launched in he domesic marke by non-residens. In addiion, domesic currency issues launched in he domesic marke by residens are also considered as inernaional issues if hey are specifically argeed a non-residen invesors. This definiion covers Euro marke offerings, 5 global bonds, 6 and foreign offerings, which include Samurai and Yankee bonds and more generally are hose bonds issued by foreign residens in domesic bond markes. 7 Equiies The daabase on equiies provides deailed informaion on he amoun of funds raised and he daes of announcemen and compleion of deals; he name and business secor of he issuer; he counry of residence and naionaliy of he issuer; he ype of issue (ADRs, iniial public offering, privaizaion, ec); he ype of offer (primary or secondary); and he marke of issue. There are differen ypes of placemens in he daabase: (1) Issuance of common or preferred equiy in he inernaional marke, (2) Issuance argeed a a paricular foreign marke, (3) Regisered socks raded on foreign markes as domesic insrumens (for example ADRs), (4) Issuance by residens in he domesic markes. We include he firs hree ypes of offerings in our inernaional equiy group. 5 Eurobonds are bonds issued and sold ouside he counry of he currency in which hey are denominaed (for example dollar-denominaed bonds issued in Europe or Asia). 6 Global bonds are single offerings srucured o allow simulaneous placemen in major markes: Euro, US, and Asia. 7 Foreign bonds are bonds issued by firms and governmens ouside of he issuer s counry, usually denominaed in he currency of he counry in which hey are issued. Samurai bonds are yen-denominaed bonds issued in Tokyo by a non-japanese company. Similarly, Yankee bonds are bonds denominaed in U.S. dollars and issued in he Unied Saes by foreign banks and corporaions. 4

6 Syndicaed Loans 8 Syndicaed loans are credis graned by a group of banks o a borrower. In a syndicaed loan, wo or more banks joinly agree o make a loan o a borrower. There is a single conrac, sill every syndicae member has a separae claim on he debor. The credior banks can be divided ino wo groups. The senior group consiss of banks acing as mandaed arrangers, arrangers, lead managers or agens. These senior banks are appoined by he borrower o bring ogeher he syndicae of banks prepared o lend money a he erms specified by he loan. The syndicae is formed around he arrangers who reain a porion of he loan and look for junior paricipans. The junior banks (managers and paricipans) consiue he second group of crediors. The number of paricipans varies according o he size, complexiy, and pricing of he loan. All paricipaing banks have earnings based on a spread over a floaing rae benchmark (ypically Libor) on he porion of he loan ha is drawn. Senior banks also have earnings relaed o various fees. The arranger and oher members of he lead managemen eam generally earn some form of upfron fee in exchange for puing he deal ogeher while he underwriers earn an underwriing fee for guaraneeing he availabiliy of fund. Oher somewha senior paricipans may also receive a paricipaion fee for agreeing o join he faciliy, wih he acual size of he fee generally varying wih he size of he commimen. As discussed in Gadanecz (24), syndicaes allow credior banks o diversify heir risk wih oher financial insiuions wihou he disclosure and markeing burden ha bond issuers face. For he smaller banks in he syndicaes, he paricipaion in a syndicaed loan allows hem o paricipae in markes ha oherwise hey would no be able o access. For more senior banks, he paricipaion in a syndicae allows hem o diversify heir sources of income since hey also earn various ypes of fees for puing ogeher he loan. We are only ineresed in inernaional syndicaed loans. We follow he BIS classificaion o idenify inernaional loans. These loans include all loans graned by syndicaes consising of a leas wo financial insiuions wih he naionaliy of a leas one of he syndicae banks being differen from ha of he borrower. The faciliies included in our daa consis of erm loans, revolving credis, co-financing faciliies, expor credi bridge faciliies, consrucion loans, mezzanine loans, or muliple opions faciliies. 8 The descripion of syndicaed loans is based on Gadanecz (24). 5

7 III. A Brief Hisory of Marke Developmen Figure 1 shows oal issuance in inernaional bond, equiy, and syndicaed-loan markes. The evidence from his figure indicaes ha inernaional financial inegraion exploded in he las wo decades as measured by gross issuance in inernaional markes, wih issuance increasing abou 1 imes in he bond and equiy markes and 3 imes for he syndicaed loan marke (saring a higher level of developmen in 198). Figures 2 and 3 explore wheher inernaional financial inegraion was indeed a global feaure. Figure 2 shows inernaional issuance separaely for OECD counries and for emerging economies, while Figure 3 allies issuance in six regions. Sill, Figures 1-3 do no provide a complee picure of marke access since hey obscure he degree of inegraion of smaller counries wih lower levels of issuance. To capure he degree of marke access of small and large counries, Figure 4 also repors he proporion of counries wih issuance in he six regions. Inernaional capial markes languish in he afermah of he crises in he 193s, only o recover owards he end of he 2 h cenury. The origins of he financial developmens of he 198s and 199s can be raced o wo marke developmens in he lae 195s and 196s. In 1957, he Briish governmen inroduces new financial resricions in he vain aemp o sop he speculaion agains he pound. In he end he devaluaion is no avered, bu he resricions make London-based banks creae a new marke o avoid losing heir share of financial ransacions: Banks dollar deposis sar o be used o provide dollar loans in an unregulaed marke, which becomes o be known as he Eurodollar marke. Oher evens furher up he liquidiy of his marke: The firs is he Cuban crisis, wih Russian banks moving heir dollar reserves from he Unied Saes o London. The second even is also he produc of anoher defense of he domesic currency agains speculaive aacks. This ime he currency under aack is he US dollar, wih he US governmen, as he Briish governmen did in 1957, inroducing capial accoun conrols in US based-banks, like heir Briish counerpar in he 195s, urn o he Eurodollar marke o avoid he resricions ha could imperil heir operaions. 9 In Sepember 1964, he Unied Saes Congress enaced he Ineres Equalizaion Tax (IET), an excise ax on purchases of new or ousanding foreign socks and bonds by U.S. residens, which lowered he rae of reurn o U.S. purchasers of foreign asses by an equivalen of 1 percenage poin. 6

8 Bu perhaps, he sraw ha broke he camel s back is he collapse of he Breon Woods sysem in Wih no need o defend he peg, counries can choose heir own moneary policy wihou he need o resric capial mobiliy and hus a new era of financial liberalizaion begins. As early as July 1973, Unied Saes eliminaes capial accoun resricions. The liberalizaion process also involved oher indusrial counries, wih Germany and Grea Briain parially eliminaing capial conrols in 1973 and Japan joining he group in In he lae 197s, Lain American counries join wih deregulaions of he capial accoun and he domesic financial secor. The firs inernaional marke o develop in he 197s is he syndicaed loan marke, paricularly wih lending o emerging markes. The dramaic surge in inernaional loans is riggered by he oil shock in , wih he high savings of OPEC counries being channeled hrough he Eurodollar marke paricularly during he period. As shown in Figure 3, loans are issued o he developing counries in Asia, he Middle Eas and Africa, and especially Lain America. The boom in syndicaed lending o emerging markes peaks a 57 billion dollars in Mexico s defaul in Augus 1982 riggers an abrup hal in lending, wih he syndicaed loan issuance declining by 5 percen. Wih banks recalling heir loans from all emerging markes, oher defauls follow. Mos of Lain American counries suspend ineres and principal paymens and hey are also followed by counries in Asia, Easern Europe, and Africa. The res of he 198s winess a collapse of he inernaional syndicaed loan marke o emerging economies: Gross issuance of syndicaed loans remained a half of he issuance reached in he early 198s. The collapse in Lain America is even more dramaic, wih loan issuance a 4 percen of he level reached in By he mid 198s, emerging markes are replaced by European counries in inernaional capial markes. I is in he 198s ha he wave of inernaional financial liberalizaion also embraces European counries as hey move owards he European Moneary Sysem. 1 Their paricipaion in he inernaional bond marke increases more han 1-fold from 6 billions of dollars in 198 o 72 billions of dollars in See Kaminsky and Schmukler (23) for a chronology of financial liberalizaion in indusrial and emerging counries. 7

9 By he end of he 198s, a new developmen ends wih he isolaion of developing markes from inernaional capial markes: The Brady plan 11 and is iniiaive o resrucure defauled loans ino bonds collaeralized by US reasuries in creae, almos overnigh, a marke for sovereign emerging marke bonds. As invesor confidence in emerging markes counries sars o recover gradually, boh he governmen and he privae secor sar issuing bonds in inernaional capial markes. Lain America benefied especially from he new inernaional bond marke. In fac, issuance in he bond marke surpassed ha of he syndicaed loan marke, wih Lain American counries bond issuance increasing from 1.5 billions of dollars in 199 o 58 billions of dollars in The Brady plan, wih is iniiaive of resrucuring disressed commercial bank loans, also provides a new impeus o he syndicaed loan marke. Helped by he easy moneary condiions in indusrial counries in he early 199s, syndicaed loans reach a new peak a 19 billions of US dollars in 1997, almos four imes higher han he level reached in he early 198s. This ime around, he larges beneficiaries in emerging markes were he Eas Asian counries, wih gross issuance reaching almos $1 billion in The naionaliy of lenders also changed: While in he early 198s mos of he syndicaes were composed of U.S. banks, in he 199s Japanese and European banks played a leading role in lending o emerging markes, especially o Eas Asian counries. The boom in he 199s in he syndicaed loan marke was no confined o emerging markes. Corporaions in indusrialized counries followed sui. By 24 inernaional syndicaed lending had increased o 2.5 rillions of US dollars and maure markes had capured he lion share of he inernaional syndicaed loan marke, wih gross issuance reaching 1.8 rillions of US dollars in 24. A new feaure of financial inegraion in he 199s is he forceful developmen of an inernaional equiy marke. In his decade, corporaions no only sar o raise capial in he highly unregulaed inernaional bond and syndicaed loan markes, bu also sar o paricipae in regulaed equiy markes in various financial ceners. For example, he liquid U.S. capial 11 The key innovaion of he Brady Plan is o allow he commercial banks o exchange heir claims on developing counries ino radeable insrumens, allowing hem o eliminae he deb from heir balance shees. 12 Brady bonds are Dollar denominaed bonds, named afer US Treasury Secreary Nicholas Brady, raded on he inernaional bond marke, allowing emerging counries o ransform nonperforming deb ino mosly collaeralized bonds. Mos of he bonds had he principal collaeralized by especially issued US Treasury 3-year zero-coupon bonds purchased by he debor counry using funding from IMF, he World Bank, and he counry s own foreign exchange reserves. Ineres paymens on Brady bonds are in some cases also guaraneed by securiies of a leas double-a raed credi qualiy held wih he New York Federal Reserve Bank. 8

10 markes sar aracing record numbers of foreign issuers and invesors in he early 199s. In paricular, many foreign issuers find i easies o raise capial in he Unied Saes hrough he creaion of American Deposiary Receip Programs, wih ADRs being raded on US sock markes in lieu of he foreign shares. Bu he U.S. sock marke is no he only one aracing foreign issuers. Wih financial inegraion of he world s capial markes escalaing, firms are now able o issue equiy underwrien and disribued in muliple foreign equiy markes, someimes simulaneously wih disribuion in he domesic marke, in wha is known as he Euroequiy marke. The so-called Euroequiy marke is jus a generic erm for inernaional securiies issues originaing and being sold anywhere in he world. The mos imporan issues in he Euroequiy marke have been hose relaed o he privaizaion of governmen-owned business, wih he Thacher governmen creaing he model for he privaizaion Briish Telecom in December A ha ime, he issue was so large ha i was deemed convenien o sell ranches o foreign invesors in addiion o he sale o domesic invesors. 13 Since hen, boh governmens in developed and emerging markes have implemened he privaizaion of saeown uiliy companies wih he help of foreign ranches. 14 Overall, inernaional equiy issuance increases from 13 billions of US dollars in 199 o 314 billions of US dollars in The magniude of equiy issues is no direcly comparable o he magniude of deb issues because unlike equiy, bonds have finie mauriies. Firms ypically roll over bonds a mauriy, and hence a par of he deb issues go owards refinancing old deb and only he remaining par is new capial. Bu he 199s as he 198s have been plagued by crises. In he afermah of hese crises, ne capial flows o emerging markes dwindle o a rickle suggesing ha he era of inernaional financial inegraion may have come o an end a leas for he developing world. Bu he evidence from gross issuance in bond, equiy, and syndicaed loan markes pains a somewha differen picure. While in he lae 198s Lain America s gross issuance in inernaional markes crashed o abou 4 percen of he levels aained in he early 198s, in he lae 199s, oal issuance declined only o abou 6 percen of is peak in Similarly, gross issuance of 13 A ranche is an allocaion of shares, ypically o underwriers ha are expeced o sell o invesors in heir designaed geographic marke. 14 One of he larges Euroequiy issues was made by Deusche Telecom A.G. ($13.3 billion in November 1996). Among iniial public offerings of governmen-owned public uiliies of emerging economies have been ha of Teléfonos de México ($2 billion in 1991) and he one by Yacimienos Perolíferos Fiscales Sociedad Anónima of Argenina ($3.4 billion in 1993). 9

11 Eas Asian counries collapsed ransiorily in 1998 and 1999 o rebound aferwards, reaching heir previous peak levels in 24. To examine he exen of paricipaion in inernaional capial markes of he counries in he various regions, Figure 4 allies he proporion of counries wih a leas one issuance per year in each of he markes. The picure of inernaional financial inegraion obained from his figure is of wo regions. The firs one, including financial ceners, oher maure economies, and Asia shows basically all counries accessing he hree inernaional markes. In conras, he oher region, including Lain America, Middle Eas and Africa, and Transiion Economies shows and area wih inerruped access o inernaional capial markes. Imporanly, access o equiy marke seems more limied while access o he syndicaed loan marke is more widespread across he various counries in each region. IV. The Model In order o analyze he behavior of inernaional issuance in bonds, loans and equiy we developed and esimaed a non saionary Bayesian dynamic laen facor model. Sandard Bayesian dynamic laen facors (as he one developed by Orok and Whieman (1998) and by Kose, Orok and Whieman (23)) require saionariy of he daa generaing process. They are herefore unsuiable o capure one of he cenral feaures of inernaional issuance in he las 3 years, i.e., he high co-movemens among issuance in differen counries and differen markes a boh business cycle and secular frequencies. For his reason, we develop a model ha allows for boh saionary and non-saionary componens in he common laen facors. Moreover, since issuance daa is available saring from differen daes in differen counries, we generalized he model in order o allow for an unbalanced panel. In he empirical analysis we sudy issuance in several regions and markes 15 over a 3 year period (i.e., bond issuance in Lain America from 198 and 25). Le N denoe he number of regions, M he number of financial insrumens per region and T he number of periods. There are N M observable variables denoed by y i m,,, i =1, 2,, N m =1, 2,, M (1) 15 In he paper, we use he words marke and insrumen inerchangeably. 1

12 where y i,m, denoes log of he issuance level of region i in marke m a ime. The co-movemens in he cross-counry panel of he observable variables are characerized by four unobservable facors, i.e., hree marke specific facors and one world facor. Boh he marke specific facors and he world facor have a permanen componen and a emporary componen. We denoe by mp f, m = b, e, l, he permanen componens in he marke facors; by mt f, m = b, e, l, he emporary componens of he marke facors; by wp f he permanen componens in he world facor; by wt f he emporary componens in he world facor. We can wrie each observable as a linear combinaion of he unobservable facors, i.e., y i,m, = a + b f + b f + b f + b f + ε (2) i,m wp i,m wp wt i,m wt mp i mp mt i mt i,m, The coefficiens of he linear combinaion, b wp i, m, loadings. They reflec he degree o which variaion in b,, wt i m mp b i,m, and and ransiory componens of he world facor and of he marke facors. 16 The sochasic process i, m, mt b i,m, are called facor y i,m, can be explained by he permanen ε represens he idiosyncraic componen of issuance in counry i and in marke m, i.e., he variabiliy of he observable ha canno be explained by movemens of he laen facors. The idiosyncraic componens are uncorrelaed across regions and across insrumens. They are assumed o be normally disribued and (possibly) serially correlaed. They follow an AR(2) process: 1 2 ε i, m, = λi, mε i, m, 1 + λi, mε i, m, 1 + µ i, m, i = 1, 2,, N m =1, 2,, M (3) where he shocks 2 µ are normally disribued whie noise processes wih variance σ i,m. i, m, Similarly, he evoluion of he emporary componen of each facor is governed by a second order auoregressive process. In paricular, f α f f + µ mt 1 mt 2 mt = m 1 + α m 1 f α f f + µ wt 1 wt 2 wt = w 1 + α w 2 mt wt m = b, e, l (4) (5) 16 Noice ha here are M N ime series o be explained by 2M+2 facors. 11

13 where he shocks T 2 T 2 σ w and σ m. mt wt µ and µ are normally disribued whie noise processes wih variances Finally, he evoluion of he permanen componens of each facor are modeled as I(1) processes. In paricular, mp w mp mp f δ + f + µ = 1 m = b, e, l (6) wp m wp wp f δ + f + µ = 1 (7) where he shocks 2 σ w,p and σ 2 m,p mp wp µ and µ are normally disribued whie noise processes wih variances ; δ w and δ m represen he drifs of he I(1) processes. i, m, Noe ha, since he shocks µ, are uncorrelaed whie noise processes, all comovemens among he observable variables are mediaed by he (permanen and ransiory) componens of he laen facors. There are wo idenificaion problems in he model we have jus described: he signs and scales of he facors and he facor loadings are no separaely idenified. Following Kose, Orok and Whieman (23), we idenify he signs of he facor loadings by requiring one of he facor loadings o be posiive for each of he facors. In paricular, we require ha he facor loading for he world facor be posiive for U.S. bond issuance; insrumen facors are idenified by posiive facor loadings for he corresponding U.S. insrumen issuance. Scales are idenified by assuming ha he variances of he innovaions in boh he permanen and emporary componens of each facor ( σ, σ, P2 w T 2 w P2 σ m, T 2 σ w and T 2 σ m, m = 1, 2 M) are equal o one. 17 As always in Bayesian analysis, all he parameers in he model are assumed o be random variables wih a given prior disribuion. We choose uninformaive prior disribuions for all he parameers of he model. The auoregressive parameers are assumed o be uniformly disribued in he region wihin which he process is saionary. 18 For each observable, we esimae he poserior densiies (given he observable daa) of he facor loadings, wp b i, m wt b i, m mt b, and, he auoregressive parameers mp i m b i, m 1 λ i,m and λ 2 i,m, and he 17 This follows Sargen and Sims (1977), and Sock and Wason (1989, 1993). 18 Such saionary region is a riangle wih poins a (-1,2), (-1,-2) and (1,). 12

14 innovaion varianceσ 2 i,m 19. Moreover, we esimae he poserior densiies of he permanen and ransiory componens of each facor, in paricular, he poserior he auoregressive parameers of he ransiory componens ( α 1 m α 2 m and 1 α w α 2 w ) and he poseriors of he drifs (δ w and δ m ). In order o esimae he poserior disribuions of he parameers, we generae random samples from he join poserior disribuion of he parameers and he unobserved facors given he daa using a Markov-Chain Mone Carlo (MCMC) procedure. Taking saring values of he parameers and facors as given 2, we firs sample from he poserior disribuion of he parameers condiional on he facors; nex we sample from he disribuion of he world facor condiional on he parameers and he insrumen facors; hen we sample each insrumen facor condiional on he world facor and he parameers. We use Meropolis-Hasing procedure o draw from he poserior disribuion of he facors given he parameers and from he poserior disribuion of all parameers. 21 Under regulariy condiions saisfied here (see Geweke, 1996 and 1997), he Markov chain so produced converges, and yields a sample from he join poserior disribuion of he parameers and he unobserved facors, condiioned on he daa. In he resul secion, we presen he average of 1,, draws from he poserior disribuions of each of he parameers and he facors. 22 In compuing he average, we discard he firs 1, draws from a burn in phase. 19 For hose observable, for which we have daa since (he firs quarer for which we have daa) he inercep is se equal o he saring value of he series (since he level of each facor is se o ). For he series saring laer han 198.4, i is se so as o fi he firs observaion wih zero error. 2 The saring values of he facor loadings for he US series are se equal o he sandard deviaions of he log changes of he series hemselves. The saring values for he marke facor drifs are se equal o he average log change in he US series divided by he saring value for he series facor loadings; he sared value of he world facor drif is se equal o ha of he bond facor drif. For all non US series, he saring values of he facor loadings on he emporary componens of he facors are se equal o he sandard deviaions of he series hemselves. For all non US series, he saring values of he facor loadings on he permanen componens are se equal o he sandard deviaions of he log changes of he series hemselves divided by he saring values of he facor drifs. The saring values for he sandard deviaions of he idiosyncraic componens are se equal o he sandard deviaions of he log changes of he respecive issuance series. The saring values for he shocks o he permanen and emporary componens of he world and insrumens facors are drawn from a sandard normal disribuion. The saring values for he auoregressive parameers are se equal o zero. The resuls ha we obain are robus when wih sar he MCMC from differen saring values. 21 The average accepance rae for all he parameers is 25%. 22 Our findings are no significanly affeced if, insead of he average, we consider he mode of he poserior disribuions. 13

15 Le us now describe he daase. We use daa on issuance for hree markes 23, he bond, loan and equiy marke. For each marke, we have daa on nine regions, four financial ceners (Unied Saes, Japan, Germany, and he Unied Kingdom) and five periphery regions (Oher Maure Economies, Eas Asia, Lain America, Middle Eas and Transiion Economies). For he periphery, we chose o group he counry daa in regions, since many counries usually issue only during some quarers of any given year. In he esimaion, we look a quarerly log levels of issuance. In order o filer ou seasonal flucuaions we ake a four quarer moving average of he raw daa. For mos regions and markes we have quarerly issuance daa from 198 unil 24; for some of he counries and regions he daa is available only saring from laer years. V. World and Marke Facors: The Esimaes To examine he evoluion of inernaional financial inegraion and marke peculiariies, Figure 5 shows he global facor and he hree marke facors. 24 The op lef panel shows he global facor. This facor capures a worldwide an uninerruped increase in issuance in he 198s. Ineresingly, during his decade all Lain American counries los access o inernaional capial markes following he deb crisis sparked by he Mexican foreign deb defaul in Augus Our esimaes of he global facor sugges ha he Lain American crisis did no have any impac on he growh of inernaional issuance. Ineresingly, he global facor shows a slowdown in inernaional issuance in he firs half of he 199s, which capures he slowdown in issuance in mos maure economies and coincides wih he recession and bond crisis in he Unied Saes, 25 he EMS crises in 1992 and 1993, and he prick of he bubble in Japan. World issuance as capured by he esimaed global facor sars recovering in 1994 and coninues o grow a an acceleraed pace unil 21 when he global 24 Since he scales of he facors and he facor loadings are no separaely idenified, o provide a dimension o he global and marke facors, he panels in Figure 5 show he produc of each facor muliplied by he mean of he absolue value of he facor loadings. Noe ha he model is esimaed in logs. 25 In he 198s, he marke for relaively risky bonds in he Unied Saes carrying Moody s raings of Ba1 or less and S&P raings of BB+ or less grew explosively. Growh was inerruped on several occasions in he face of failures by prominen issuers and a major marke maker. Afer rapid expansion beween 1982 and 1986, issuance remained a high levels hrough he res of he decade. Then, in 199, i pracically disappeared wih he collapse of Drexel Burnham Lamber, previously he larges underwrier and marke maker in junk bonds. Issuance rose sharply over he nex several years as he economy recovered and oher firms became acive underwriers. 14

16 economy sars o slow down 26 and uncerainy heighens following he aacks on Sepember 11. As shown in Figure 1, inernaional capial markes sar recovering in 23 following he widespread signs of he global economic upurn, wih he esimaed global facor capuring his dramaic upsurge in issuance. The nex hree panels show he worldwide common evoluion of issuance in he hree markes: bonds, equiies, and syndicaed loans. In conras o he global facor ha capures he overall common movemen in issuance in all inernaional capial markes, hese hree facors capure he common flucuaion in inernaional issuance wihin each marke. As shown by he bond marke facor, overall issuance in his marke soars in he early 198s. The spur in growh in he 198s of he inernaional bond marke is closely linked o he wave of inernaional financial liberalizaion in European counries as hey move owards he European Moneary Sysem. Their paricipaion in he inernaional bond marke increases more han 1-fold from 6 billions of dollars in 198 o 72 billions of dollars in The growh in inernaional bond issuance capured by he bond facor in he 198s seems o be also linked o he overall moneary condiions in indusrial counries. For example, he acceleraion in issuance raes in he mid 198s followed by he slowdown in 1987 coincides wih he easing in U.S. moneary condiions in followed by he ighening of 1987 and he U.S. bond and sock marke collapse. Following he slowdown in he lae 198s, he bond facor shows coninuous growh wih a relaively mild slowdown during he ighening of moneary condiions in indusrial counries in 1994 and during he afermah of he Mexican crisis. The nex panel racks he equiy facor. The evoluion of his facor shows a highly pronounced boom-bus paern. The firs peak occurs righ before he sock and bond marke crash in 1987, wih he equiy facor capuring a marke slowdown unil This boom-bus paern reflecs he evoluion of equiy issuance in he financial ceners and oher maure economies. During he early 199s, he equiy facor reflecs a new upurn in issuance in par due o he access of emerging markes o inernaional equiy markes. This is he ime of he process of privaizaion of large public firms in Lain America. Saring in 1994, his facor capures a slowdown in equiy issuance, fosered in par by he Mexican, Asian, and Russian crises. The las boom-bus paern capured by he equiy facor is relaed o he upurn in 26 As described in he BIS Quarerly Review, a variey of disappoining macroeconomic daa and profi announcemens, such as he lower-han-expeced Sepember U.S. employmen repor and he July German indusrial producion index spread gloom in global capial markes around he world. 15

17 issuance of maure economies, wih he boom ending in 2 wih he world sock marke collapse and amid signs of a weakening world economy. Only by he end of 22 equiy issuance had surged again. Finally, he loan facor capures he common flucuaions in he syndicaed loan marke. In conras o he equiy facor, he loan facor does no capure he booms and buss in he inernaional syndicaed marke suggesing ha hese booms and buss are an idiosyncraic phenomenon in each region and are no coordinaed. For example, he sharp decline in syndicaed loan issuance of Lain American counries saring in 1982 does no spread worldwide. Similarly, he sudden sop in issuance of Eas Asian counries following he crisis in 1997 is circumscribed o ha region and does no spread o oher emerging counries or maure economies. To examine he exen of paricipaion of he various regions in he inernaional capial markes we look a wo measures. Firs, we esimae he share of he variance of he changes in issuance in each marke due o he world facor and he insrumen facor. This firs measure capures he exen of co-movemen of quarerly flucuaions in issuance in each region wih he worldwide shocks as capured by he global and insrumen facors over he whole sample, ha is, from 198 o 25. Second, we examine he paern of he idiosyncraic componen of oal issuance for each region o evaluae wheher some regions lag in he process of inernaional financial inegraion or wheher he evidence suggess he presence of excessive booms and buss in emerging markes as suggesed by Sigliz (1998). Table 1 shows he variance decomposiion of bonds, equiies, and syndicaed loans issuance for each region. Since he world, marke, and idiosyncraic facors are orhogonal, he variance of gross issuance series can be decomposed as 27 wp 2 wp wt 2 wt var( yi, m ) = (bi,m ) var( f ) + (bi,m ) var( f ) + (bi,m ) var( f ) + (bi,m ) var( f ) + var( ε mp 2 mp mp 2 mp i, m ) To measure he exen of inegraion of each region i and marke m, we propose wo indices: 27 Even hough he facors are uncorrelaed, samples aken a each pass of he Markov chain will no because of sampling error. To ensure adding up, we orhogonalized he sampled facors, ordering he world facor firs and he marke facor second. The sample correlaion beween he raw facors was small so he order of orhogonalizaion has no impac on he resuls. 16

18 1. Index of Global Financial Inegraion: This index reflecs he exen of co-movemen of issuance of region i and marke m wih all markes and regions 28 : ( b Index of Global financial inegraion for region i and marke m = wp i,m ) 2 wp var( f ) + ( b var( y wt i,m i,m ) ) 2 var( f wt ) 2. Index of Marke Financial Inegraion: This index capures he exen of co-movemen of issuance in of region i and marke m wih issuance in marke m in all oher regions. Tha is, his index capures he worldwide synchronizaion of issuance by markes. ( b i Index of Marke financial inegraion for region i and marke m = mp m, ) 2 mp var( f ) + ( b var( y i,m mp i, m ) ) 2 var( f mp ) Noe ha he share of he variance explained by he idiosyncraic facor, var( ε var( y capures he exen of insulaion of issuance in a paricular marke in one of he regions o world shocks and generalized marke shocks. Table 1 summarizes he exen of world and marke inegraion for each region and for each marke. To have a broad assessmen of inegraion (co-movemen) in each marke, he op panel of he able shows he average indices of global and marke inegraion as well as he share of he variance explained by idiosyncraic flucuaions separaely for bonds, equiies, and loans across all nine regions in our sample. The evidence in his op panel shows ha flucuaions in issuance in he equiy marke are subsanially more coordinaed han hose in bonds or loans markes. The co-movemen in flucuaions in equiy issuance around he world is wice as high as he co-movemen observed in bonds and loans markes. The average idiosyncraic componen in equiy markes can jus explain 37 of he flucuaions in issuance. In conras, he average idiosyncraic componen across all regions for bonds and loans markes explains more han 6 percen of he variance of oal issuance. i,m i,m ) ) 28 This measure (and he oher ones ha we presen in his Secion) is calculaed a each pass of he Markov chain. We repor he median of heir poserior disribuions. 17

19 The nex panels provide a higher resoluion picure of he exen of he co-movemen in issuance for each marke and region. Ineresingly, when we examine deb insrumens (bonds and loans) Japan sands ou as he less inegraed maure economy, wih inernaional issuance being mosly explained by idiosyncraic facors raher han by common movemens across markes and regions: he variance of he idiosyncraic facor explains 84 percen of he oal variance for he bond marke and 89 percen for he loan. Similarly, Lain America and he Middle Eas regions are he wo less inegraed regions among maure economies. Inernaional issuance in hese wo areas is mosly explained by idiosyncraic facors, wih he share of he idiosyncraic facor in oal variance oscillaing beween 8 and 94 percen of he oal variance in hese regions. In sharp conras, issuance in he maure counries region is in large par explained by world shocks, wih he share of he variance explained by idiosyncraic facors being 18 and 12 percen of he variance of issuance in he bonds and loans markes, respecively. To have a sense of synchronizaion of inernaional flucuaions, boh a a global and marke level, Table 2 shows he sign of he loading facors for all he regions and markes. We examine deb markes separaely from equiy markes because in he case of bonds and loans markes mos of he co-movemen across regions is capured by he marke facor. Ineresingly, for bonds and loans, all he facor loadings of he permanen componen of he marke facor across he all regions are posiive, indicaing ha permanen flucuaions in global financial inegraion affeced basically all regions in he same direcion. In conras, ransiory shocks affec various regions in opposie direcions. In he case of equiy markes, boh he global and he marke facors explain in large par he flucuaions in issuance in his marke. Wih he excepion of Japan and he Middle Eas counries, he loading facors of he permanen componens are all posiive, again indicaing ha global and marke shocks affeced issuance around he round in he same direcion. This is no he case wih ransiory shocks. Figures 6 and 7 show oal issuance in he hree markes, boh acual values and hose prediced using he global and marke facors. Figure 6 shows oal issuance of he financial ceners and Figure 7 shows oal issuance of he financial periphery. Several feaures of hese figures are noeworhy. Firs, he facor model seems o predic quie well he flucuaions in issuance in mos maure markes boh in he 198s and he 199s, suggesing no ime-varying paerns of financial inegraion for hese regions. Second, he global and marke facors do no 18

20 explain movemens in oal inernaional issuance of Japan. 29 The esimaed idiosyncraic facor model uncovers a ime-varying paern in inernaional issuance of Japan, wih inernaional issuance exceeding world paerns in he 198s, lagging relaive o world developmens in he early 199s, and again recovering somewha in he lae 199s and again in 23. Third, global and marke facors do no explain as well he flucuaions in inernaional issuance in emerging markes. In paricular, in he case of Asia and Lain America here is evidence of boom-buss cycles in inernaional issuance when compared wih he paern of issuance in inernaional markes. Fourh, ransiion economies are shown as lagging in inernaional issuance when compared wih he paern esimaed using he global and marke facors, only caching up since 21. VI. Deerminans of Idiosyncraic Facors: Preliminary Esimaions As shown in our esimaions financial markes have seadily become more inegraed globally, wih boh governmens and corporaions around he globe increasingly accessing inernaional markes o fund heir aciviies. 3 Bu inegraion has no proceeded a he same pace around he globe. In paricular, emerging economies access o inernaional capial markes has flucuaed widely and as capured by our esimaions wih booms and buss in various regions. Naurally, changing economic condiions, resricions o capial mobiliy, and poliical facors may explain he counry-specific characerisics of inernaional issuance. We now relae he esimaed idiosyncraic componen o various economic and poliical indicaors. In hese preliminary esimaions, we examine he role of regional poliical risk and risk in inernaional capial markes. 31 The qualiy of insiuions, he exen of corrupion, governmen s abiliy o carry ou is declared programs, and is abiliy o say in office may influence inernaional issuance. To 29 The global and marke facors do explain equiy primary issuance in Japan as discussed before. Figure 6 shows oal issuance. Since bond and loan issuance is far much larger han equiy issuance, his figure reflecs he behavior of bond and loan issuance. 3 I is rue ha in perfecly inegraed capial markes, households can diversify heir porfolios inernaionally, and hence boh governmens and corporaions would no need o raise capial from ouside heir borders. Sill, perhaps because of liquidiy of domesic capial markes or resricions in domesic financial markes, firms and governmens have o direcly raise capial from abroad o ake advanage of lower cos of capial ouside he counry borders. 31 Obviously, he sae of he economy should be a naural indicaor of financing needs. We are now consrucing indices of producion for he nine regions in our sample using quarerly daa o mach he frequency of he issuance daa. 19

21 capure his possibiliy we use he index of poliical risk published in he Inernaional Counry Risk Guide (ICRG). This is a composie index ha assesses poliical sabiliy and he qualiy of governance of he counry. The poliical sabiliy indicaors provide rankings on socioeconomic pressures a work in sociey ha could consrain governmen acion or fuel social dissaisfacion, as well as rankings of domesic poliical violence or ehnic ensions. The indicaors on governance provide rankings on corrupion wihin he poliical sysem as well as assessmens of he srengh and imparialiy of he legal sysem and of popular observance of he law. There is also informaion on he insiuional srengh and qualiy of he bureaucracy. A counry rank in he 8-1 percen range is considered very low risk while a counry ranked below 5 percen is considered very high risk. We also include in our esimaions wo measures of risk in inernaional capial markes. Our firs measure is an esimae of he ime-varying variance of he Morgan Sanley Capial Inernaional World index. Our second measure is he erm premium calculaed as he difference beween he U.S. 1-year-noe yield minus he U.S. 1-year Treasury Bill rae. Table 3 repors panel esimaions for maure and emerging economies. The op panel repors he esimaes for emerging counries. Our resuls indicae ha low poliical risk affecs posiively inernaional issuance. In paricular, if a counry/region moves upward in one range (for example from high o moderae risk range), inernaional issuance would increase 4 billion dollars (abou 17 percen of he average quarerly issuance across emerging markes in 25. Finally, volailiy in inernaional capial markes adversely affecs he counry-specific issuance in emerging markes. Boh he volailiy in he world sock marke and he erm-premium affec adversely inernaional issuance of emerging markes. The boom panel shows he resuls for maure economies. Again, poliical risk maers, wih beer counry raings increasing inernaional issuance. The effecs in his case are smaller. If a counry/region moves upward in one range, inernaional issuance would increase 3 billion dollars (abou 1.4 percen of he average quarerly issuance across maure economies in 25). In conras o he resuls for emerging markes, marke volailiy does no affec adversely he idiosyncraic issuance componen in maure economies. In fac, issuance in maure economies increases in imes of urmoil suggesing fligh o qualiy, wih inernaional invesors swiching from buying emerging marke securiies owards purchasing asses issued by indusrial economies. 2