Oil Shocks, US Uncertainty, and Emerging Corporate Bond Markets

Abstract

Using a structural VAR model, this paper investigates how oil price shocks and US uncertainty affect emerging market corporate bond returns. The key finding is that the response of emerging market corporate bond returns varies significantly depending on the underlying sources of oil price changes. Oil supply shocks generally have a negative impact on corporate bond returns, while aggregate demand and oil market-specific demand shocks lead to a temporary increase in returns, followed by a gradual fall. That is, when oil price increases are driven by stronger global economic activity or by speculative demand reflecting increased risk appetite, they can lead investors to search for higher yields in emerging markets, and thus raise corporate bond returns in the short term. Conversely, an unexpected rise in US uncertainty strengthens investors’ risk aversion and results in a substantial decline in emerging market corporate bond returns. These findings have crucial policy implications not only for portfolio strategies of global investors, but also for government authorities in emerging market economies.