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Banco de Espa

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Title: Banco de Espa


1
Banco de España Investment Banks
Recommendations and Emerging Markets The Usual
Suspects
Javier SantisoChief Economist and Acting
Director OECD Development Centre
? Madrid - January 2008?
2
Overview
Objective
1
Capital Flows and Research Publications
2
Determinants of Banks Recommendations
3
Conclusions and Policy Lessons
4
3
Two core questions
  • Do recommendations given by investment banks have
    an impact on the allocation of portfolio flows in
    the emerging markets?
  • What is behind investment banks recommendations?
    A work in process
  • - Recommendations and the business of
    investment banks (i.e. bond issuances by
    sovereigns).
  • - Financial Markets analysts and political
    events in emerging democracies.

4
Overview
Objective
1
Capital Flows and Brokers Publications
2
Determinants of Banks Recommendations
3
Conclusions and Policy Lessons
4
5
Recommendations Database
  • Construction of a unique database containing the
    recommendations given by the major investment
    banks to the Latin American bond markets
  • - Over 3 800 observations.
  • - 12 Major Investment Banks.
  • - Covering the period 1997-2007.
  • - Direct and strict link between financial
    intermediaries and investors (not public
    information).

6
Recommendations Database
  • We have taken the recommendations given by 12
    investment banks. All of them important players
    in the emerging bond markets, i.e. market makers.


7
Recommendations Database

8
Recommendations Database
  • Example Average of the recommendations given to
    Brazil by the investment banks (lhs) with respect
    to the weight of Brazil in the EMBI Global index
    (rhs).


9
Recommendations Database
  • We have taken 11 Latin American countries that
    represent nearly 95 of the GDP of the region.
  • The total number of recommendations is over
    3,800.


10
Capital Flows to Emerging Countries
  • A large body has studied the determinants of
    capital flows
  • Push factors or global factors.
  • Fernandez-Arias (1996) and Calvo et al (1993).
  • Pull factors or local factors.
  • Taylor and Sarno (1997) and Alfaro et al
    (2005).
  • Information and distance.
  • Savastano (2000), Papaioannou (2004) and
    Portes and Rey (2005).

11
Determinants of capital flows
  • Impact of recommendations on capital flows (Bond
    flows and Equity flows respectively)
  • (i)
  • (ii)
  • where and percentage
    allocated by funds in country i with respect to
    the total amount invested in emerging economies.
  • the average of the investment
    banks recommendations given to country i.
  • Pull macroeconomic variables
    defined by capital markets (exchange rate, spread
    of sovereign bonds and rate of return of equity).

12
Determinants of capital flows
  • Pull macroeconomic variables that are
    strongly influenced by real sector (economic
    activity, inflation rate and interest rate).
  • country invariant variables which capture
    global factors (US nominal rates and US
    industrial production).
  • Period of the analyses 1997-2005 for equity
    flows
  • 2002-2006 for bond flows
  • Frequency Monthly.
  • Countries Argentina, Brazil, Chile, Colombia,
    Mexico, Peru and Venezuela.

13
Determinants of bond flows

14
Determinants of equity flows

15
Determinants of capital flows
  • Three results
  • The impact of investment banks recommendations
    on capital flows is positive and significant.
  • The impact of the recommendations given to
    external public debt goes beyond sovereign bond
    flows. Indeed, although their influence is minor,
    these recommendations also affect private equity
    flows.
  • 3. This new microeconomic variable improves the
    fit of capital flows regressions more than some
    traditional macroeconomic variables such as
    interest rates, economic growth and inflation
    rate.

16
Overview
Objective
1
Capital Flows and Brokers Publications
2
Determinants of Banks Recommendations
3
Conclusions and Policy Lessons
4
17
Recommendations and Research Literature
  • Variety of results
  • Analysts are confronted with a trade-off between
    sending true signals and optimistic signals.
    Jackson (2005).
  • Larger number of buy recommendations than sell
    recommendations. Barber et al (2001).
  • Market reaction to upgrades is less pronounced
    than the market reaction to downgrades by
    analysts. Asquith et al (2005).
  • Impact of the measures introduced by the NYSE and
    NASDAQ, but also the sanctions established by the
    SEC in 2002. Madureira (2004), Boni and Womack
    (2002) and Unger (2001).

18
Recommendations and Research Literature
  • Empirical studies of the relationship between the
    recommendations and underwriters are concentrated
    to OECD countries.
  • Agrawal et al (2008), Lin et al (1998), Krigman
    et al (2001), Dechow et al (2000) and Michaely
    and Womack (1999).
  • Research literature concentrated in emerging
    markets is scarce and exclusively concentrated in
    the equity market.
  • Bacmann and Bollinger (2001), Seasholes (2000
    and 2004) and Chang et al (2000).

19
Investment banks business
  • Banks are faced with a trade-off concerning
    recommendations
  • While sell side business could have the incentive
    to build reputation by giving accurate
    information in the long term .
  • . in the short term recommendations could be
    biased in order to obtain short term profits.
  • Additionally, investment banking activities could
    be motivated to recommend optimistically the
    assets which they are participating as
    underwriters in an IPO.

20
Underwriters recommendations
  • - 90 of the underwriters recommend at the issue
    date to buy or to maintain in their portfolio the
    bonds issued by the countries where they are
    acting as underwriters.

21
Size of the Market and Recommendations
  • As the size of the market increases, the
    recommendation tends to become increasingly
    favourable too big to underweight.


22
The Argentinean Case
  • 67 per cent of the recommendations were to
    maintain the positions in Argentinean External
    Debt (prior 2001). Two examples
  • Morgan Stanley We are maintaining our Market
    Perform recommendation on Argentine
    bonds.Relaxation of fiscal targets and an
    innovative IMF-led financial package from
    creditors both improve Argentinas credit
    outlook. Argentina needs to raise an estimated
    2.6 billion to fulfil its first quarter
    financing requirements. New issues are expected
    to total 5.6 billion in 2001. Growth and fiscal
    performance are becoming the focus of investors
    attention. January 26, 2001.
  • Salomon Smith Barney (Citigroup) The successful
    implementation of the IMF support package with
    the associated debt management transactions and
    the change in the global outlook probably
    increases the chances that economic activity will
    pick up in the second half of the year. We
    therefore recommend a neutral position in
    external bonds and local currency instruments.
    January 17, 2001 .


23
Underwriters Recommendations
  • Structure of the Underwriting Market Few number
    of participants.

24
Underwriters Recommendations
  • The probability that a government continues at
    state t1 with the same lead manager used in the
    previous period (t) is reduced.

25
Underwriters Recommendations
  • Given the structure of the market, there is an
    incentive for non-underwriters to give an equal
    or better recommendation than underwriters.

26
Underwriters Recommendations
  • A possible variable that represents the conflict
    of interest of banks could be the countries
    participation in the banks primary bond markets
    business (by using a long run analysis).
  • Two years

27
Underwriters Recommendations
  • 3 years

28
Underwriters Recommendations
  • and 4 years.
  • Moreover, some investment banks have specialized
    the origination business in small countries.

29
Political and Financial Crisis
Nominal exchange rate depreciation
Elections
Countrys Total
and government change
1989
17
1
Colombia
13
1,16
1990
14
2
Costa Rica
11
1991
3
3
Guatemala
11
1,14
1992
0
4
Ecuador
10
1,12
1993
10
5
Chile
10
1994
18
6
Peru
10
1,1
1995
6
7
Honduras
10
1,08
1996
8
8
Paraguay
9
1997
7
9
Brazil
9
1,06
1998
15
10
El Salvador
9
1,04
1999
12
11
Republica Dom.
9
2000
11
1,02
12
Uruguay
9
2001
4
13
Mexico
9
1
2002
13
14
Argentina
8
0,98
2003
8
15
Nicaragua
8
2004
6
16
Panama
8
0,96
2005
5
17
Venezuela
8
Source Frieden, Ghezzi y Stein, 2001
0,94
2006
11
18
Bolivia
7
-9
-8
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
30
Political and Financial Crisis Some countries
achieved to decouple both cycles Mexico in 2000.
Timing of Presidential Elections and Exchange
Rate Depreciations in Mexico, 1975-2000
Election Year
Election Year
Election Year
Election Year
Election Year
Source Jorge Blázquez and Javier Santiso, 2004.
31
Political and Financial Crisis Others have
overcome the test of fire more recently Brazil
in 2006
Source Based on Juan Martínez and Javier
Santiso, 2003.
32
Political Events and Bond Recommendations
  • Over the course of 2006, all the most important
    Latin American Countries (by excepting
    Argentina) elected their head of the state.


33
Political Events and Bond Recommendations
  • In comparison to previous election periods, the
    elections of 2006 point to a markedly improved
    confidence.


34
Political Events and Bond Recommendations
  • The Brazilian Case (2002 vs. 2006) Da Lula
    Preta (2002)


35
Political Events and Bond Recommendations
  • The Brazilian Case (2002 vs. 2006).
  • A Lula de Mel (2006). An Ex-Emerging Market?


36
Political Events and Bond Recommendations
  • Chile Political event is not an issue. An
    Ex-Emerging Market? During the presidential
    elections of 2000 and


37
Political Events and Bond Recommendations
  • Chile Political event is not any more an issue
  • the Presidential elections of 2006.


38
Political Events and Recommendations
  • Mexico A risk country before the election date.
  • In 2000 due to the risk of transparency of the
    election process.


39
Political Events and Bond Recommendations
  • Mexico A risk country before the election
    date.
  • In 2006 due to the risk of AMLO (López Obrador).


40
Political Events and Bond Recommendations
  • Are financial markets becoming less sensitive
    to Latin American Election Cycles? Probably YES,
    although Ecuador...


41
Determinants of the recommendations
  • Impact of political events on investment banks
    recommendations
  • where is the average of the investment
    banks recommendations given to country i.
  • Pull macroeconomic variables
    defined by capital markets Exchange rate, spread
    of sovereign bonds, equity return, investment
    value and the weight of the
    country i in the EMBI Global index (proxy of
    conflict of interest) .

42
Determinants of the recommendations
  • Pull macroeconomic variables that are
    strongly influenced by real sector (industrial
    production, inflation rate and interest rate).
  • country invariant variables which capture
    global factors (US nominal rates, US industrial
    production and US High Yield spread).
  • is a dummy variable that takes the
    value of 1 during presidential elections (3
    months before and after the month of the
    election).
  • Period of the analyses 1997-2007
  • Frequency Monthly.
  • Countries Argentina, Brazil, Chile, Colombia,
    Ecuador, Mexico, Peru, Uruguay and Venezuela.

43
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44
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45
Determinants of the recommendations
  • The investment value of sovereign bonds and the
    conflict of interest are significant explanatory
    variables behind banks recommendations.
  • The Political Cycle is a determinant variable in
    explaining investment banks recommendations.
    More than some standard macro variables.
  • The temporal horizon of investment banks
    recommendations is short term depending more on
    the continuity of macro policies than on
    structural reform.
  • The credibility and stability of economic
    policies has improved in the eyes of Capital
    Markets analysts. Political risk however still
    remains an important consideration requiring
    further efforts on behalf of governments and
    political parties.

46
Overview
Objective
1
Capital Flows and Research Publications
2
Determinants of Banks Recommendations
3
Conclusions and Policy Lessons
4
47
Investment banks recommendations
  • The impact of investment banks recommendations
    on capital flows is positive and significant.
  • What are the determinants of investment banks
    recommendations? Investment banks business and
    political events could be important factors.

48
Policy Lessons
  • There is a need for more detailed information
    disclosure by investment banks Push for
    financial markets transparency.
  • Government agencies should do a strategic
    monitoring on what financial market are writing
    about their respective country vulnerabilities
    Monitor markets cognitive regimes.
  • Given that banks recommendations and portfolio
    flows are related, an international co-operation
    scheme needs to be established to encourage
    Market Makers to cover more countries A Public
    Private Patnership in emerging markets finance?

49
Policy Lessons
  • Emerging Markets Covered by Financial
    Institutions in 2006
  • ( of total brokers)

50
  • Thank you!
  • Presentation based on
  • Nieto Parra and Santiso (2007). The Usual
    Suspects A Primer on Investment Banks
    Recommendations and Emerging Markets. OECD
    Development Centre Working Paper, 258.Nieto
    Parra and Santiso (2008). Enter the Matrix Wall
    Street and Elections in Emerging Democracies.
    OECD Development Centre Working Paper,
    Forthcoming.
  • http//www.oecd.org/dev
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