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Transcript of Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid -...
Banco de España
Investment Banks’ Recommendations and Emerging Markets: The Usual
Suspects
Madrid - January
2008
Javier Santiso
Chief Economist and Acting Director
OECD Development Centre
2
ObjectiveObjective11
Capital Flows and Research PublicationsCapital Flows and Research Publications22
Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations33
Overview
Conclusions and Policy LessonsConclusions and Policy Lessons44
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
ObjectiveObjective11
Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations
22 Capital Flows and Brokers PublicationsCapital Flows and Brokers Publications
33
Overview
Conclusions and Policy LessonsConclusions and Policy Lessons44
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.
Institution Name of the Publication Periodicity Start Date
ABN AMRO Emerging Markets Fortnightly Bi-weekly Jan-04
Barclays Capital LatAm Drivers Fortnightly Bi-weekly Feb-04
Bear Stearns Emerging Markets Sovereign Journal Weekly Weekly Feb-06
Citigroup (Citi-Salomon Brothers) Economics/Strategy Monthly Jul-97
Credit Suisse (CSFB) Debt Trading Monthly Monthly May-01
Deutsche Bank Emerging Markets Monthly Monthly Sep-01 to Dec-05
Dresdner Kleinwort Wasserstein EM Strategist Monthly Jan-04
Goldman Sachs Emerging Markets Strategy Bi-Weekly Aug-01 to Aug-03
JP Morgan Emerging Markets Outlook and Strategy Monthly Jan-01
Lehman Brothers Emerging Markets Compass Bi-Weekly Sep-04
Merrill Lynch Emerging Markets Debt Monthly Monthly Feb-03
Morgan Stanley EMD Perspectives Quarterly Quarterly 1Q-00
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).
Brazil: Sovereign Bond Index Weight (%, EMBI Global)
10
15
20
25
30
J ul-97 J ul-98 J ul-99 J ul-00 J ul-01 J ul-02 J ul-03 J ul-04 J ul-05 J ul-06
Source:The authors from J P Morgan, 2007
Brazil: Recommendations(1:overweight, 0:neutral, -1:underweight)
-1,00
-0,50
0,00
0,50
1,00
J ul-97 J ul-98 J ul-99 J ul-00 J ul-01 J ul-02 J ul-03 J ul-04 J ul-05 J ul-06
Source:The authors from investment banks' publications, 2007
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.
ABN BARC. BS CITI CSFB DB DK GS JPM LB ML MS TOTALArgentina 11 3 14 86 65 50 8 24 67 18 25 24 395
Brazil 11 13 15 89 66 50 8 25 67 18 33 24 419Chile 11 13 6 87 65 0 0 25 64 18 0 0 289
Colombia 11 13 15 88 65 50 8 25 67 18 32 24 416Dominican Rep 0 0 12 17 1 0 0 2 58 0 10 16 116
Ecuador 1 13 15 88 60 50 8 25 66 18 33 24 401Mexico 11 13 14 89 66 50 8 25 67 18 33 24 418Panama 0 13 9 68 62 50 8 25 67 0 33 24 359
Peru 1 13 14 89 65 50 8 25 67 18 33 24 407Uruguay 0 0 12 22 58 0 0 16 61 18 10 0 197
Venezuela 11 12 13 90 61 50 8 25 67 18 33 24 412TOTAL 68 106 139 813 634 400 64 242 718 162 275 208 3829
Part. Underwriting 4% 3% 2% 10% 5% 11% 2% 10% 23% 0% 7% 10% 87%
Source: The authors from investment banks' publications (for recommendations) and Dealogic (for underwriting),2007
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).
ittitititit PushalMarketcBond ReRe
ittitititit PushalMarketcEquity ReRe
itBond itEquity
itcRe
itMarket
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.
tPush
italRe
13
Determinants of bond flowsDependent variable: Bond
I II III IV V VI VII VIII IX X XI XIIRecommendations 1.112*** 1.120***
(8.08) (8.35)Exchange Rate (Market ) 0.001*** 0.002*** 0.002*** 0.003***
(4.0) (5.1) (5.21) (7.23)Spread (Market ) -0.078*** -0.103*** -0.066*** -0.093***
(-9.48) (-12.24) (-9.25) (-13.17)Stock (Market ) -0,0004 -0,0014 0.0022* 0,0018
(-0.27) (-0.81) (1.77) (1.35)Inflation rate (Real ) 0.021** 0,016 0,007
(2.14) (1.47) (0.6)Economic Activity (Real ) 0.033*** 0.035*** 0.036***
(3.25) (3.08) (3.08)Interest rate (Real ) 0,009 0,000 -0.034***
(1.22) (0) (-3.87)US interest rate (Push) -0.186*** -0.288*** 0,071
(-2.83) (-4.05) (0.83)US ind. production (Push) -0.051* -0.072** -0,044
(-1.66) (-2.11) (-1.08)Recommendations -1 1.062*** 1.095***
(7.47) (7.89)Exchange Rate -1 (Market ) 0.001*** 0.002*** 0.002*** 0.003***
(4.07) (5.22) (5.22) (7.18)Spread -1 (Market ) -0.072*** -0.096*** -0.062*** -0.088***
(-8.01) (-10.38) (-7.79) (-11.26)Stock -1 (Market ) -0,002 -0.004** 0,002 0,002
(-1.35) (-2.01) (1.51) (1.19)Inflation rate -1 (Real ) 0.024** 0.024** 0,009
(2.45) (2.24) (0.75)Economic Activity -1 (Real ) 0.034*** 0.037*** 0.039***
(3.1) (3.14) (3.42)Interest rate -1 (Real) 0,005 -0,005 -0.034***
(0.64) (-0.65) (-3.9)US interest rate -1 (Push) -0.173** -0.254*** 0,036
(-2.45) (-3.35) (0.44)US ind. production -1 (Push) 0,026 0,023 0.123***
(0.8) (0.64) (3.09)Cons 5.634*** 6.188*** 6.264*** 6.332*** 5.539*** 5.393*** 5.376*** 5.687*** 5.921*** 6.286*** 5.472*** 5.332***
(12.23) (12.35) (24.55) (18.71) (22) (19.44) (13.62) (13.34) (33.97) (19.35) (21) (18.76)
N (Observations) 322 322 322 322 322 322 322 322 322 322 322 322
Adjusted R-squared 0,57 0,48 0,01 0,16 0,54 0,44 0,52 0,43 0,03 0,17 0,49 0,39
t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.
FIXED EFFECTS (2002 - 2005)
14
Determinants of equity flowsDependent variable: Equity
I II III IV V VI VII VIII IX X XI XIIRecommendations 0.518*** 0.579***
(5.9) (6.07)Exchange Rate (Market ) 0,0002 0.0005*** -0.0005*** -0.0004**
(1.18) (2.58) (-3.01) (-2.34)Spread (Market ) -0.031*** -0.034*** -0.036*** -0.043***
(-5.44) (-5.6) (-6.88) (-7.89)Stock (Market ) 0.0039** 0.0055*** -0,0009 0,0003
(2.57) (3.61) (-0.74) (0.26)Inflation rate (Real ) 0.013** 0,007 -0,005
(2.33) (1.26) (-1.05)Economic Activity (Real ) 0,006 0,007 0.022**
(0.67) (0.79) (2.36)Interest rate (Real ) 0.024*** 0.025*** 0.018***
(3.83) (3.91) (2.96)US interest rate (Push) 0.307*** 0.34*** 0.345***
(10.39) (11.26) (14.34)US ind. production (Push) -0.039** -0.045** -0,009
(-2.16) (-2.41) (-0.56)Recommendations -1 0.58*** 0.640***
(6.67) (6.72)Exchange Rate -1 (Market ) 0,0002 0.0006*** -0.0006*** -0.0004**
(1.14) (2.7) (-3.06) (-2.43)Spread -1 (Market ) -0.032*** -0.033*** -0.035*** -0.042***
(-5.57) (-5.50) (-6.71) (-7.86)Stock -1 (Market ) 0,002 0.004*** -0,001 0,001
(1.37) (2.6) (-0.62) (0.90)Inflation rate -1 (Real ) 0.016*** 0.009* -0,004
(2.92) (1.73) (-0.81)Economic Activity -1 (Real ) 0,011 0,010 0.027***
(1.24) (1.14) (2.99)Interest rate -1 (Real) 0.027*** 0.026*** 0.021***
(4.33) (4.06) (3.46)US interest rate -1 (Push) 0.287*** 0.323*** 0.308***
(9.25) (10.06) (11.9)US ind. production -1 (Push) 0,015 0.027* 0.057***
(0.98) (1.65) (3.86)Cons 1.729*** 1.717*** 2.243*** 3.303*** 3.970*** 4.083*** 1.570*** 1.540*** 2.195*** 3.216*** 3.939*** 4.071***
(8.09) (7.8) (20.65) (19.94) (33.56) (34.99) (7.55) (7.17) (22.64) (19.55) (33.41) (35.17)
N (Observations) 657 691 721 714 660 698 650 689 721 713 653 697
Adjusted R-squared 0,32 0,28 0,23 0,01 0,13 0,09 0,33 0,29 0,25 0,02 0,14 0,09
t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.
FIXED EFFECTS (1997 - 2005)
15
Determinants of capital flows
Three results:
1. The impact of investment banks’ recommendations on capital flows is positive and significant.
2. 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
ObjectiveObjective11
Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations
22 Capital Flows and Brokers PublicationsCapital Flows and Brokers Publications
33
Overview
Conclusions and Policy LessonsConclusions and Policy Lessons44
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.
Underwriters' recommendations (Announcement date of the issue)Jan. 1999 - Feb 2007
OVER. (%) NEUTRAL (%) UNDER. (%) # ISSUESArgentina 0,0 66,7 33,3 9Brazil 58,0 42,0 0,0 38Chile 20,0 60,0 20,0 5Colombia 37,5 62,5 0,0 32Dom. Rep. 0,0 100,0 0,0 2Ecuador 50,0 50,0 0,0 2Mexico 29,0 54,8 16,1 31Panama 0,0 71,4 28,6 14Peru 46,2 38,5 15,4 13Uruguay 0,0 100,0 0,0 1Venezuela 66,7 26,7 6,7 15TOTAL 38,0 52,0 10,0 162Source: The authors from Investment Banks' recommendations and Bloomberg, 2007
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”.
Average Recommendation EMBI-Global country weights EMBI-Global spreads (1:over; 0:neutral; -1:under.) (%) Basis Points (bp)
Argentina -0,14 11,1 2536,7Brazil 0,35 19,3 774,9Chile 0,00 1,0 139,1Colombia 0,12 2,2 496,1Dom. Rep. -0,01 0,3 656,4Ecuador -0,03 1,3 1391,6Mexico 0,29 16,8 342,0Panama -0,03 1,9 376,4Peru 0,05 1,7 486,5Uruguay -0,32 0,7 609,5Venezuela 0,16 5,3 798,7Correlation with recomm. (with Argentina) 0,65 -0,30Correlation with recomm. (without Argentina) 0,81 -0,04Source: The authors, from Investment banks' publications and JP Morgan, 2007
Recommendations vs. Credit Risk and Size of the Countries (Average 1997-2006)
22
The Argentinean Case67 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 Argentina’s 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.
# Issues ABN BARCLY. CITI CSFB DB GS JPM ML MS UBS TOTALArgentina 53 1,0 1,4 7,7 9,9 17,3 6,2 19,2 2,3 17,6 0,0 82,7Brazil 57 0,9 0,4 10,9 4,2 9,4 12,0 16,9 9,1 12,9 5,1 81,7Chile 7 0,0 0,0 31,2 0,0 25,1 0,0 37,0 6,7 0,0 0,0 100,0Colombia 45 3,8 0,0 13,9 11,4 3,8 13,4 22,1 11,8 11,6 4,8 96,6Dom. Rep. 3 0,0 0,0 21,4 0,0 0,0 0,0 50,0 0,0 28,6 0,0 100,0Ecuador 1 0,0 0,0 0,0 0,0 50,0 0,0 50,0 0,0 0,0 0,0 100,0Mexico 35 0,0 6,0 9,9 7,1 4,9 17,1 28,7 1,0 12,1 4,1 90,9Panama 12 0,0 0,0 39,9 0,0 5,0 3,5 16,9 0,0 34,6 0,0 100,0Peru 11 0,0 0,0 24,0 4,8 13,5 0,0 41,8 4,8 3,8 7,2 100,0Uruguay 23 1,3 0,0 22,3 6,2 16,7 0,0 11,9 10,7 7,1 19,5 95,7Venezuela 17 20,6 3,4 2,9 20,6 14,0 0,0 14,9 3,4 0,0 9,7 89,5Source: The authors from Bloomberg and Dealogic, 2007
Participation (%) of the underwriters in Latin American Countries (Jan. 1999-April 2007)
24
Underwriters’ Recommendations
The probability that a government continues at state t+1 with the same lead manager used in the previous period (t) is reduced.
ABN BARCLY. CITI CS DB GS JPM ML MS UBS Nomura DrKW Finantia Millen. HSBC UniC. ING BNP. BS Total ABN 0,0 0,0 0,0 0,0 0,0 0,0 50,0 33,3 16,7 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100
BARCLY. 0,0 0,0 0,0 0,0 16,7 0,0 16,7 0,0 0,0 33,3 0,0 0,0 0,0 0,0 16,7 0,0 0,0 16,7 0,0 100CITI 0,0 0,0 4,5 13,6 4,5 18,2 13,6 27,3 4,5 4,5 0,0 4,5 0,0 0,0 4,5 0,0 0,0 0,0 0,0 100CS 5,3 0,0 5,3 0,0 10,5 10,5 5,3 5,3 5,3 5,3 0,0 10,5 0,0 0,0 0,0 21,1 0,0 10,5 5,3 100DB 0,0 11,1 7,4 7,4 3,7 11,1 18,5 3,7 3,7 7,4 7,4 14,8 0,0 0,0 3,7 0,0 0,0 0,0 0,0 100GS 9,4 4,7 0,0 4,7 18,8 3,1 10,9 14,1 17,2 3,1 0,0 9,4 0,0 0,0 0,0 0,0 0,0 0,0 4,7 100
JPM 2,5 2,5 7,6 10,2 12,7 5,1 9,3 12,7 10,2 6,8 10,2 2,5 0,0 0,0 2,5 0,0 0,0 2,5 2,5 100ML 3,8 3,8 11,5 0,0 23,1 6,4 2,5 3,8 17,9 3,8 15,4 3,8 0,0 0,0 0,0 0,0 0,0 0,0 3,8 100MS 0,0 0,0 4,7 4,7 4,7 9,4 12,5 14,1 9,4 12,5 9,4 14,1 0,0 0,0 0,0 0,0 0,0 4,7 0,0 100UBS 0,0 11,1 11,1 11,1 11,1 11,1 16,7 0,0 0,0 5,6 11,1 11,1 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100
Nomura 0,0 0,0 25,0 16,7 0,0 0,0 8,3 0,0 8,3 0,0 0,0 16,7 8,3 8,3 0,0 0,0 0,0 0,0 8,3 100DrKW 4,5 0,0 4,5 0,0 9,1 0,0 13,6 9,1 4,5 4,5 27,3 4,5 0,0 0,0 4,5 0,0 0,0 13,6 0,0 100
Finantia 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 0,0 0,0 0,0 100Millen. 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 0,0 0,0 0,0 100HSBC 0,0 0,0 10,0 10,0 0,0 10,0 40,0 10,0 0,0 20,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100
UniCredit 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 0,0 100ING 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 100BNP. 0,0 0,0 0,0 0,0 41,7 16,7 33,3 0,0 0,0 8,3 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100BS 0,0 0,0 16,7 0,0 0,0 16,7 16,7 16,7 0,0 0,0 0,0 16,7 0,0 0,0 16,7 0,0 0,0 0,0 0,0 100
Source: The author based on Dealogic, 2007
where: ABN is ABN AMRO, BARCLY is Barclays Capital, BS is Bear Stearns, CITI is Citigroup, CS is Credit Suisse, DB is Deutsche Bank, DrKW is Dresdner Kleinwort Wasserstein, GS is Goldman Sachs, JPM is JP Morgan, ML is Merrill Lynch, MS is Morgan Stanley, Millen. is Millennium BNP. is BNP Paribas and UniC is Unicredit Group.
Lead Managers´ Transition Matrix (%) Brazilian Case (May 1995-Dec. 2006)
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.
Underwriters vs No-Underwriters' recommendations (Announcement date, Average 1999-2006)
-0,6
-0,4
-0,2
0
0,2
0,4
0,6
0,8
Arg
.
Bra
zil
Chi
le
Col
ombi
a
Dom
. R
ep.
Ecu
ador
Mex
ico
Pan
ama
Per
u
Uru
guay
Ven
ez.
Tot
. A
ver.
Wei
gth.
Ave
r.
Source: The authors, 2007
Underw riter
No underw riter
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…
Countries Participation in JP Morgan's Latam Primary Bond Market Business (%) (during the last 2 years)
0
10
20
30
40
50
60
70
80
Jul-9
7
Jul-9
8
Jul-9
9
Jul-0
0
Jul-0
1
Jul-0
2
Jul-0
3
Jul-0
4
Jul-0
5
Jul-0
6
Source: The authors based on Dealogic, 2007
Argentina Brazil
Colombia Mexico
Venezuela
Countries Participation in Merrill Lynch's Latam Primary Bond Market Business (%) (during the last 2 years)
0
10
20
30
40
50
60
70
80
90
100
Jul-9
7
Jul-9
8
Jul-9
9
Jul-0
0
Jul-0
1
Jul-0
2
Jul-0
3
Jul-0
4
Jul-0
5
Jul-0
6
Source: The authors based on Dealogic, 2007
Argentina Brazil
Chile Colombia
Mexico
27
Underwriters’ Recommendations
3 years…
Countries Participation in Citibank's Latam Primary Bond Market Business (%) (during the last 3 years)
0
10
20
30
40
50
60
70
Jul-9
7
Jul-9
8
Jul-9
9
Jul-0
0
Jul-0
1
Jul-0
2
Jul-0
3
Jul-0
4
Jul-0
5
Jul-0
6
Source: The authors based on Dealogic, 2007
Argentina Brazil
Chile Colombia
Mexico
Countries Participation in Deutsche Bank's Latam Primary Bond Market Business (%) (during the last 3 years)
0
10
20
30
40
50
60
70
80
90
Jul-9
7
Jul-9
8
Jul-9
9
Jul-0
0
Jul-0
1
Jul-0
2
Jul-0
3
Jul-0
4
Jul-0
5
Jul-0
6
Source: The authors based on Dealogic, 2007
Argentina Brazil
Chile Mexico
Venezuela
28
Underwriters’ Recommendations
and 4 years. Moreover, some investment banks have specialized the origination business in small countries.
Countries Participation in Bear Stearns's Latam Primary Bond Market Business (%) (during the last 4 years)
-
10
20
30
40
50
60
70
80
90
100
Aug
-00
Aug
-01
Aug
-02
Aug
-03
Aug
-04
Aug
-05
Aug
-06
Source: The authors based on Dealogic, 2007
Barbados
Brazil
Grenada
J amaica
Mexico
Countries Participation in Morgan Stanley's Latam Primary Bond Market Business (%) (during the last 4 years)
0
10
20
30
40
50
60
70
80
90
100
Feb
-98
Feb
-99
Feb
-00
Feb
-01
Feb
-02
Feb
-03
Feb
-04
Feb
-05
Feb
-06
Source: The authors based on Dealogic, 2007
Argentina Brazil
Colombia Mexico
Panama
29
Political and Financial Crisis
Nominal exchange rate depreciation
and government change
0,94
0,96
0,98
1
1,02
1,04
1,06
1,08
1,1
1,12
1,14
1,16
-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9
Source: Frieden, Ghezzi y Stein, 2001
Country`s Total Elections 1 Colombia 13 1989 172 Costa Rica 11 1990 143 Guatemala 11 1991 34 Ecuador 10 1992 05 Chile 10 1993 106Peru 10 1994 187 Honduras 10 1995 68 Paraguay 9 1996 89Brazil 9 1997 7
10 El Salvador 9 1998 1511Republica Dom. 9 1999 1212 Uruguay 9 2000 1113Mexico 9 2001 414 Argentina 8 2002 1315 Nicaragua 8 2003 816Panama 8 2004 617 Venezuela 8 2005 518 Bolivia 7 2006 11
30
Political and Financial Crisis
Some countries achieved to decouple both cycles: Mexico in 2000.
-30
-20
-10
0
10
20
30
40
50
60
70
01/0
1/19
75
01/1
0/19
76
01/0
7/19
78
01/0
4/19
80
01/0
1/19
82
01/1
0/19
83
01/0
7/19
85
01/0
4/19
87
01/0
1/19
89
01/1
0/19
90
01/0
7/19
92
01/0
4/19
94
01/0
1/19
96
01/1
0/19
97
01/0
7/19
99
01/0
4/20
01
Source: Jorge Blázquez and Javier Santiso, 2004.
Timing of Presidential Elections and Exchange Timing of Presidential Elections and Exchange Rate Depreciations in Mexico, 1975-2000Rate Depreciations in Mexico, 1975-2000
Election Year
Election Year
Election Year
Election Year
Election Year
31
Political and Financial Crisis
Others have overcome the test of fire more recently: Brazil in 2006
20%
25%
30%
35%
40%
45%
-180
-80
20
120
220
320
420
520
bp
Voter intention for Lula in the opinion polls
(left)
Spread Brazil-Emerging Countries and Electoral Polls1994
20%
22%
24%
26%
28%
30%
32%
-100
-50
0
50
100
150
200
pb.
Voter intention for Lula in the opinion polls
(left)
Spread Brazil-Emerging Countries and Electoral Polls1998
Source: Based on Juan Martínez and Javier Santiso,
2003.20%
25%
30%
35%
40%
45%
0
200
400
600
800
1000
1200
1400
Voter intention for Lula in the opinion polls
(left)
bp.Spread Brazil-Emerging Countries and Electoral Polls2002
Source: Datafolha, JP Morgan
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.
Country Date First/Second Round
Venezuela December 3, 2006
Ecuador November 26, 2006 Second round
Nicaragua November 5, 2006
Brazil October 29, 2006 Second round
Ecuador October 15, 2006 First Round
Brazil October 1, 2006 First Round
Mexico July 2, 2006
Peru June 4, 2006 Second round
Colombia May 28, 2006
Peru April 9, 2006 First Round
Haiti February 7, 2006
Costa Rica February 5, 2006
Chile January 15, 2006 Second roundSource: The authors, 2007
Presidential Elections Date (2006)
33
Political Events and Bond Recommendations
In comparison to previous election periods, the elections of 2006 point to a markedly improved confidence.
Latin America: recommendations(1:overweight, 0:neutral, -1:underweight)
-1.00
-0.50
0.00
0.50
1.00
J an-98 J an-99 J an-00 J an-01 J an-02 J an-03 J an-04 J an-05 J an-06 J an-07
Source:The authors from investment banks' publications, 2007
Simple Average
Weighted Average
34
Political Events and Bond Recommendations
The Brazilian Case (2002 vs. 2006): “Da Lula Preta (2002)…
Brazil Presidential Election Day 0 = 27 Oct 2002
1000
1200
1400
1600
1800
2000
2200
2400
2600
-100 -75 -50 -25 0 25 50 75 100
Source: Thomson Financial Datastream, The authors, 2007
90
100
110
120
130
140
150
Sovereign Bond Spread (lhs.)
Exchange Rate (basis 100=-100)
First Round Second Round
Brazil: recommendations(1:overweight, 0:neutral, -1:underweight)
-1,00
-0,50
0,00
0,50
1,00
J ul-97 J ul-98 J ul-99 J ul-00 J ul-01 J ul-02
Source:The authors from investment banks' publications, 2007
Presidential election date
35
Political Events and Bond Recommendations
The Brazilian Case (2002 vs. 2006).
…A Lula de Mel” (2006). An Ex-Emerging Market?
Brazil: recommendations(1:overweight, 0:neutral, -1:underweight)
-1,00
-0,50
0,00
0,50
1,00
J an-02 J an-03 J an-04 J an-05 J an-06 J an-07
Source:The authors from investment banks' publications, 2007
Presidential election date
Brazil Presidential Election Day 0 = 29 Oct 2006
150
200
250
300
-100 -75 -50 -25 0 25 50 75 100
Source: Thomson Financial Datastream, The authors, 2007
90
92
94
96
98
100
102
104
Sovereign Bond Spread (lhs.)
Exchange Rate (basis 100=-100)
Second RoundFirst Round
36
Political Events and Bond Recommendations
Chile: Political event is not an issue. An Ex-Emerging Market? During the presidential elections of 2000 and…
Chile: recommendations(1:overweight, 0:neutral, -1:underweight)
-1,00
-0,50
0,00
0,50
1,00
J ul-97 J ul-98 J ul-99 J ul-00 J ul-01
Source:The authors from investment banks' publications, 2007
Presidential election dateChile Presidential Election Day 0 = 16 Jan 2000
50
100
150
200
250
300
-100 -75 -50 -25 0 25 50 75 100
Source: Thomson Financial Datastream, The authors, 2007
80
85
90
95
100
105
110
Sovereign Bond Spread (lhs.)Exchange Rate (basis 100=-100)
Second RoundFirst Round
37
Political Events and Bond RecommendationsChile: Political event is not any more an issue
… the Presidential elections of 2006.
Chile: recommendations(1:overweight, 0:neutral, -1:underweight)
-1,00
-0,50
0,00
0,50
1,00
J ul-01 J ul-02 J ul-03 J ul-04 J ul-05 J ul-06
Source:The authors from investment banks' publications, 2007
Presidential election dateChile Presidential Election Day 0 = 15 Jan 2006
0
25
50
75
100
-100 -75 -50 -25 0 25 50 75 100
Source: Thomson Financial Datastream, The authors, 2007
80
85
90
95
100
105
Sovereign Bond Spread (lhs.)Exchange Rate (basis 100=-100)
Second Round
First Round
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.
Mexico: recommendations(1:overweight, 0:neutral, -1:underweight)
-1,000
-0,500
0,000
0,500
1,000
J ul-97 J ul-98 J ul-99 J ul-00 J ul-01
Source:The authors from investment banks' publications, 2007
Presidential election dateMexico Presidential Election Day 0 = 2 Jul 2000
270
320
370
420
-100 -75 -50 -25 0 25 50 75 100
Source: Thomson Financial Datastream, The authors, 2007
95
97,5
100
102,5
105
107,5
110
Sovereign Bond Spread (lhs.)Exchange Rate (basis 100=-100)
Election date
39
Political Events and Bond Recommendations
Mexico: A risk country before the election date.
In 2006 due to the risk of AMLO (López Obrador).
Mexico Presidential Election Day 0 = 2 Jul 2006
110
135
160
-100 -75 -50 -25 0 25 50 75 100
Source: Thomson Financial Datastream, The authors, 2007
98
100
102
104
106
108
110
Sovereign Bond Spread (lhs.)
Exchange Rate (basis 100=-100)
Election date
Mexico: recommendations(1:overweight, 0:neutral, -1:underweight)
-1,000
-0,500
0,000
0,500
1,000
May-02 May-03 May-04 May-05 May-06
Source:The authors from investment banks' publications, 2007
Presidential election date
40
Political Events and Bond Recommendations
Are financial markets becoming less sensitive to Latin American
Election Cycles? Probably YES, although Ecuador...
Risk
From beginning 2000's
t - 1 To 2006
Ecd. 06
No Risk Risk
t + 1
Br. 06 Ch. 06 Col. 06 Ven. 06
Peru. 06 Mex. 06
Br. 02 Col. 02 Ecd. 02 Peru. 01Mex. 00
Ch. 00Ven. 00
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) .
itMarket
itittititti PoliticalPushaleRMarketc ,Re
tic ,Re
)( ,, tMti rr
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.
tPush
italRe
itPolitical
43
Dependent variable: RecommendationsI II III IV V
Exchange Rate (Market ) 0.00000001 0.00000001
(0.67) (0.74)
Spread bp (Market ) -0.0000851*** -0.00008*** -0.00008*** -0.000073*** -0.000079***(-5.61) (-4.98) (-5.09) (-4.85) (-5.21)
Equity (Market ) 0.2176716*** 0.1898*** 0.1913*** 0.17845*** 0.1969***(3.75) (3.67) (4.00) (3.72) (4.06)
Inflation rate (Real ) 0.27420* 0.2630*
(1.74) (1.70)
Industrial Production (Real ) 0.5346*** 0.4995*** 0.4337** 0.43082** 0.41969**(3.12) (2.94) (2.56) (2.53) (2.47)
Var. Interest rate (Real ) 0.0016522 0.00178
(0.38) (0.40)
Var. US interest rate (Push) 0.05544(0.45)
US ind. production (Push) -0.19816(-0.24)
US High Yield (Push) 0.0001593(1.21)
Weight Average (Market) 0.01589*** 0.01567*** 0.01493*** 0.015077*** 0.01522***(5.68) (5.65) (6.01) (6.06) (6.11)
Investment Value (Market) 2.272125*** 2.24*** 2.4249*** 2.4829*** 2.467***(7.29) (7.41) (9.05) (9.30) (9.18)
Presidential Elections ( t-3 , t+3 ) -0.1719525*** -0.1768*** -0.1326***(-3.47) (-3.61) (-2.85)
Presidential Elections before 2006 ( t-3 , t+3 ) -0.12319**(-2.17)
Presidential Elections in 2006 ( t-3 , t+3 ) -0.1236*(-1.67)
Cons -0.08563 -0.0017 0.02417 .0126834 0.0102(-0.98) (-0.05) (0.81) (0.43) (0.35)
N (Observations) 792 792 867 867 867
Adjusted R-squared 0.2059 0.2066 0.2183 0.2152 0.2135
t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.
Pooled Regression (1997 - 2007)
Determinants of Investment Banks' Recommendations: OLS
44
Dependent variable: RecommendationsI II III IV V
Exchange Rate (Market ) 0.000286*** 0.00003***(4.51) (4.68)
Spread bp (Market ) -0.000056*** -0.0000552*** -0.000053*** -0.000049*** -0.0000568***(-2.67) (-3.02) (-2.86) (-2.63) (-3.04)
Equity (Market ) 0.17351*** 0.1566194*** 0.200647*** 0.185257*** 0.2050916***(2.99) (3.24) (4.18) (3.85) (4.21)
Inflation rate (Real ) 0.04752(0.27)
Industrial Production (Real ) 0.41874** 0.4614104*** 0.43687*** 0.43474*** 0.42149**(2.45) (2.77) (2.59) (2.57) (2.49)
Var. Interest rate (Real ) 0.002224(0.52)
Var. US interest rate (Push) -0.0231347( -0.19)
US ind. production (Push) 0.475532(0.58)
US High Yield (Push) 0.00014(1.08)
Investment Value (Market) 2.272125*** 2.158372*** 2.3859*** 2.45534*** 2.43761***(7.56 ) (7.93) (8.81) (9.10) (8.96)
Presidential Elections ( t-3 , t+3 ) -0.1719525*** -0.1651272*** -0.148641***(-3.46) (-3.61) (-3.22)
Presidential Elections before 2006 ( t-3 , t+3 ) -0.14745***(-2.62)
Presidential Elections in 2006 ( t-3 , t+3 ) -0.12356*(-1.68)
Cons -0.8528637*** 0.026696 0.1170015*** 0.106045*** .1036628***(-3.93) (0.84) (4.62) (4.28) (4.14)
N (Observations) 792 867 867 867 867
Adjusted R-squared 0.1925 0.1948 0.1741 0.1707 0.1668 t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.
Determinants of Investment Banks' Recommendations: FIXED EFFECTS
Fixed Effects (1997 - 2007)
45
Determinants of the recommendations
1. The investment value of sovereign bonds and the conflict of interest are significant explanatory variables behind banks’ recommendations.
2. The Political Cycle is a determinant variable in explaining investment banks’ recommendations. More than some standard macro variables.
3. The temporal horizon of investment banks’ recommendations is short term depending more on the continuity of macro policies than on structural reform.
4. 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
ObjectiveObjective11
Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations
22 Capital Flows and Research PublicationsCapital Flows and Research Publications
33
Overview
Conclusions and Policy LessonsConclusions and Policy Lessons44
47
Investment banks’ recommendations
1. The impact of investment banks’ recommendations on capital flows is positive and significant.
2. What are the determinants of investment banks’ recommendations? Investment banks’ business and political events could be important factors.
48
Policy Lessons
1. There is a need for more detailed information disclosure by investment banks : Push for financial markets transparency.
2. Government agencies should do a strategic monitoring on what financial market are writing about their respective country vulnerabilities: Monitor markets cognitive regimes.
3. 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
-
20
40
60
80
100
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Mex
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nes
Chi
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Hun
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Uru
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Chi
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Mal
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Kor
ea
Tha
iland
Egy
pt
Indi
a
Ukr
aine
Pan
ama
Bul
garia
Tai
wan
Ser
bia
Hon
g K
ong
Cze
ch R
ep.
Sin
gapo
reV
ietn
am
Rom
ania
S
lova
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Isra
el
Leba
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Mor
occo
Nig
eria
T
unis
iaD
omin
ican
Rep
.
Alg
eria
Côt
e d'
Ivoi
re
Pak
ista
n
Emerging Markets Covered by Financial Institutions in 2006 (% of total brokers)
• Note: Countries most frequently analysed by Emerging Markets Analysts or covered by leading financial institutions. The percentage represents the average presence in their analysis. Only countries analysed by more than 25 per cent of the selected financial reports appear on the graph.
• Source: Nieto and Santiso (2007), calculation according to 10 selected investment banks 3 relevant emerging market indices 1 global association of financial Institutions.
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