Wednesday, April 12, 2006

The story about bond and equity

Does the coexistence of bonds and equities support the mean reversion theory? More specifically emerging market bonds. I remember reading an ariticle a couple of months ago suggesting that high yield bonds should behave in a way similar to equities. An explanation was not given but i presume this statement comes from the fact that emerging market bonds (high yield) and equities offer a higher return to investors. Apart from that, the erratic and stochastic behavior of emerging markets' interest rates suits the definition of equities perfectly. Could the movement of funds between these two instruments cause rates and prices to revert along their respective long-run averages? The dramatic decline in emerging market bond spread over the years adds complication to the question asked. I am thinking of all the possibilities causing the thinning of bond spreads Changes in liquidity, fundamentals and monetary policy, I believe these factors carry ramifications but which one of these should I point my finger to. Any comments? If the thinning of the bond spread is attributable to strong and robust economic fundamentals over recent years, the current tightening of monetary policy to contain inflationary pressure would have minimal implication on spreads. In contrast, should the thinning of bond spreads be caused excess liquidity in the market, a tighter monetary policy would eventually lead to a reversal in the spreads. I have yet to see any reversals in the market, thus I am assuming the Asian region has pretty strong fundamentals, fingers crossed, I hope this applies to Malaysia too! Continuation to come when I ponder on this issue again...lunch break!


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