Domestic Currency Emerging Market Bonds Pricing and Risk Management Aspects

Abstract

Domestic currency emerging market bonds form an indirect way of trading currency and credit risk. It is true that unlike eurobonds or Bradys, domestic currency emerging market bonds have no default risk in a classical sense. These bonds are issued by local governments and can be paid one way or another by newly issued currency, if need be. Instead, they carry a significant "devaluation risk". In this paper we discuss the environment that supports such bonds, introduce the main parameters and risks, and compare some ways of modelling and pricing these instruments. The paper illustrates that a non-parametric interest rate modelling will be more appropriate for pricing local currency emerging markets bonds.