Foreign bond investors and market discipline

Abstract

This article scrutinizes the impact of foreign bond ownership on market discipline, that is the mutual responsiveness of financial markets and sovereign borrowers. The empirical investigation covers 12 advanced economies during the Great Moderation (1981–2008). This article finds no evidence that foreign bond investors affect the sensitivity of bond spreads to fiscal policy. Reversely, results show that government responsiveness to market pressure is contingent on the make-up of its investor base. Bond spreads spur on fiscal consolidation. The larger the share of foreign bond investors, the bigger this effect.