An Empirical Investigation of Eastern European Bond Markets

ABSTRACT

We examine the value of Eastern European emerging bond markets to global fixed income managers. In an environment where bonds from traditional developed markets are offering modest yields, emerging market bonds with attractive yields are becoming more popular with institutional managers. Furthermore, the returns on these bonds exhibit low correlations with traditional fixed income investments and thus offer opportunities for portfolio diversification. We develop a multifactor forecasting model and estimate its parameters using a dynamic Kalman filter procedure. The forecasts are then used to construct optimal mean–variance portfolios with and without emerging market bonds. We find that the portfolios that include emerging market bonds have significantly higher Sharpe ratios.

KEY WORDS:

• bond portfolio
• Eastern European emerging market (EEEM)
• Kalman filter

Notes

^1. “Stocks, Bonds, Bills and Inflation Yearbook”, Ibbotson Associates, Chicago 2011.

^2. Portfolio return of DMs is $0.0643=0.419r_1(Canada)+0.1502r_2(UK)+0.4308r_3(Australia)$.