Liquidity in emerging country bond markets: A comparison of bid-ask spread proxies and determinants of bid-ask spread

Abstract

Many of the emerging market countries have been issued large amounts of local currency bonds in order to finance their budget deficits. Therefore, the attention to the emerging country bonds increased and, different aspects of these assets are investigated in order to analyse market microstructures. Liquidity is one of the most important characteristics of the financial assets and markets. As liquidity affects asset returns, investment decisions and market characteristics, all of the market participants are attracted to measurement and forecast of a financial security's liquidity. So, liquidity measurement is essential to understand market dynamics. The bid-ask spread, which is the difference between the best bid and ask prices, represents the explicit trade costs, and is an important liquidity measure. In this thesis, we look for an efficient way to estimate the bid-ask spread for sovereign bonds, and analyze the bond-specific and country-specific determinants of the bid-ask spread in the emerging market countries. The performances' of the bid-ask spread measures are compared, and the bond-level characteristics' effects on the bid-ask are investigated. We implement empirical analysis on two distinct data sets. For the first data set, we analyze Turkish sovereign bonds traded in Borsa Istanbul Debt Securities Market. We build a relative quoted bid-ask spread as a benchmark using intraday quote data, and compare the forecast performances of the bid-ask spread measures. According to the regression results, the spread measures that use low-frequency data are able to represent and estimate spread dynamics, and Closing Percent Quoted Spread outperforms the other measures. Moreover, a panel data analysis is applied to investigate the bond specific features' effects on the bid-ask spread, and the regression analysis shows that bond liquidity is significantly affected by bond specific features. The shorter term to maturity or the greater trade volume, the narrower relative bid-ask spread. Further, bond type is significantly influential on the bid-ask spread. For the second data set, we analyze sovereign bonds from six emerging market countries. A panel regression model is implemented in order to examine the country-level and bond-level features' effects on the sovereign bond bid-ask spread and liquidity. According to our empirical analysis, issuer country credit risk, market return and bond yield are statistically significant determinants of the bid-ask spread for emerging country sovereign bonds.