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• Introducing the bond market indicators under the multidimensional indicator system
• Using multidimensional system to diagnose dimensions of bond markets in countries
Bond market development indicators
Information incommensurate with growth Bond financing, both international and domestic, has become an integral and significant part of countries’ and firms’ financing, especially for emerging market economies. The size of the glo- bal bond market has grown from $25 trillion in 1990 to $57 trillion in 2004, while that of emerging mar- kets has increased from $1 trillion to $4 trillion.
International bond financing due to its market ori- ented nature, being susceptible to short-run de- velopments that affect prices, can be volatile.
Domestic bond markets are still less developed in many countries. Therefore, information on this form of financing is particularly important, espe- cially for countries that are relatively new partici- pants. Presently, information on emerging market economies’ international bonds is more compre-
hensively captured and documented than that on their domestic bond markets. This is partly because the development of domestic bond markets in gen- eral lags that of international markets, yet there is a greater interest in monitoring on part of interna- tional investors.
Overall, efforts on measuring bond market devel- opment for a large cross-section of countries other than high income ones, remain limited. The FSDI project, as part of its objective to assess compre- hensively financial systems, introduces indicators for monitoring bond markets as per the four di- mensions of the financial system—size, access, efficiency and stability (refer to FSDI dossier for information on the concept and framework utilized).
Information organized per these dimensions helps
Size
Ratio of private sector bonds to GDP Ratio of public sector bonds to GDP Ratio of international bonds to GDP Dummy variable: Existence of bond market
Dummy variable: Existence of corporate bond market
Access
Government bond yields (3 months and 10 years) Ratio of domestic to total debt securities
Ratio of private to total debt securities (domestic) Ratio of new corporate bond issues to GDP New corporate bond issued ($ billion)
Efficiency
Quoted bid-ask spreads (10-yr government bond yield) Turnover of private sector bond on securities exchange Turnover of public sector bond on securities exchange Settlement Efficiency Index
Stability
Volatility of sovereign bond index Skewness of sovereign bond index
Ratio of short-term to total bonds (domestic)
Ratio of short-term bond to total bonds (international) Correlation with German bond returns
Correlation with US bond returns Bond market indicators in FSDI
understand better the relative development of bond markets around the world, as well as the strengths and weaknesses of each dimension.
Size
The size dimension comprises the most commonly used measures of bond markets, notwithstanding that the other three dimensions can be equally im- portant. Ideally, FSDI would like to record compre- hensively the size of bond markets globally. How- ever, given the limited amount and reliability of data from many developing countries, this goal cannot be met. Nonetheless, as a first step, utilizing docu- ments, statistical handbooks, websites and corre- spondence with individual securities exchanges around the world, a map (below) depicting the trad- ing of bonds (public and corporate) has been put together.
For the measure of size, public, private and inter- national bonds are included. This section discusses first the indicators of the size of bond markets and then briefly comments on the determinants.
Public sector bond markets
Based on the World Bank’s Financial Structure Database, FSDI utilizes the basic measure of pub- lic bond market size, namely, the ratio of public sector bonds to GDP. This measure is avail- able for most countries since 1990.
The public sector bond market size varies across regions and income groups. In terms of both ab- solute and relative (to GDP) terms, North America leads the rest of the world, with the largest bond market, followed by Europe, where in some indi- vidual countries public bond markets are more developed than in the U.S. Asia outperforms Latin America, for which the relative measure (as a ratio of GDP) is the smallest among all developing re- gions (left graph, next page). High income OECD countries have substantially larger bond markets, while the relative size of bond markets in middle
Documenting the existence of bond markets worldwide
More than 130 countries have some bond securities traded on exchanges. These countries cover nearly 77% of the world’s gross domestic product (measured at purchas- ing power parity term) and 91% of world’s population.
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income countries is generally indistinguishable from the one in low income countries, even though the difference may be significant in absolute terms.
Private sector bond markets
FSDI documents global trading of corporate bonds, which is also depicted in the world map. A total of 104 countries, covering 75% of world GDP and 85% of world population, have corporate bonds traded on securities exchanges. As a measure of private sector bond issues, the ratio of private sector bond to GDP is available since 1990. The graph below shows the relative distribution of pri- vate sector bonds to GDP for different income
groups. The change in the ranking of income groups compared with public sector bonds is no- ticeable.
International bond issues
International bonds in part reflect a country’s abil- ity to raise capital globally, and in FSDI this is mea- sured by the ratio of international bonds to GDP.
Developing countries, because of limitations in the management of their fiscal and exchange rate poli- cies, have difficulty utilizing international markets, although there has been significant progress in their cross-border bond issuance since the mid- 1990s. Almost 96% of the international debt secu-
High Low
Lebanon Saudi Arabia
Liberia Pakistan
Iceland India
Netherlands China
Ireland Iran
Ranking by ratio of Int'l. bonds to GDP (%)
0%
10%
20%
30%
40%
50%
93 95 97 99 01 03
Ratio of public sector bond to GDP, by income Percent
High Income:OECD
Lower Middle Income
High Income: Other Low Income
Upper Middle Income
0%
10%
20%
30%
40%
50%
2000 2001 2002 2003
Ratio of private sector bond to GDP, by income Percent
High Income:OECD
Lower Middle Income High Income: Other
Low Income Upper Middle Income 15%
25%
35%
45%
55%
2000 2001 2002 2003
Ratio of public sector bond to GDP, by region Percent
North America
Sub Saharan Africa Europe & Central Asia
East Asia & Pacific South Asia
Latin America & Caribbean
rities outstanding are accounted for by high-income countries. Most developing countries, e.g., Paki- stan, Iran etc., have low international bond to GDP ratios. However, some developing countries, like Lebanon and Liberia, have a high international bond to GDP ratio (table, previous page).
Determinants of bond market size
The size of a country plays an important role in determining whether it operates a securities ex- change (Clayton, Jorgensen, and Kavajecz, 2006).
A literature survey suggests that this is also appli- cable to bond markets. Countries with less devel- oped or non-existent domestic bond markets are in general small countries. And countries with small financial markets tend to have small bond mar- kets. The correlation coefficient between the ra- tios of international bond to GDP and private credit to GDP has a value of 35%. However, small coun- tries can overcome the size constraint and de- velop bond markets by issuing bonds in foreign countries and foreign currencies, or by developing common securities exchanges and spreading the infrastructure costs among members.
The size of the bond market, measured by private sector bond to GDP ratio is positively correlated with the size of the banking sector (left graph, be-
low). Academic literature, such as Claessens, Klingebiel, and Schmukler (2003) and Burger and Warnock (2005), show that the main determinant of the size of the bond market is the protection of creditor rights in a country. Creditors are willing to purchase arm’s length securities’ products such as corporate bonds, only when they are convinced that their claims will be repaid without too much difficulty. The graph (below, right) illustrates the positive correlation between countries’ institutional framework, which incorporates creditor rights, and the ratio of private sector bonds to GDP.
Access
Access, especially with regard to domestic mar- ket is useful and effective only when the cost of capital is low and the process of obtaining capital for the domestic private sector is relatively easy.
Cost of capital: As a proxy measure of the cost of capital, data on 3-month and 10-year govern- ment bond yields are collected utilizing informa- tion from the World Federation of Exchanges (WFE).
Ease of access: To measure access, two indica- tors are created based on data from the Bank for International Settlements:
0%
20%
40%
60%
80%
100%
120%
1 3 5 7 9
Creditor protection and bond market development Ratio of private sector bonds to GDP (%)
Creditor Rights Index
Denmark
Australia Peru
France
0%
20%
40%
60%
80%
100%
120%
5 105 205
Banking sector and bond market development Ratio of private sector bonds to GDP (%)
Ratio of private credit to GDP (%) Italy
Netherlands
Switzerland Argentina
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(i) Ratio of domestic bonds to total bonds out- standing. This reflects the capacity of local mar- kets to provide capital for issuers. It is assumed that in order to reduce currency mismatch, an is- suer would prefer raising capital domestically than internationally, unless the domestic market is un- derdeveloped.
(ii) Ratio of private sector bonds to total do- mestic bonds outstanding. This indicator helps measure the convenience of obtaining capital for the domestic private sector. The composition of a country’s outstanding debt securities also reflects the ease of access to capital for private borrow- ers. This information is important from the per- spective of borrowers, and the private sector in particular, as it makes apparent the degree of ac- cessibility and thus affects financing decisions.
Using Thomson Financial as a source, data on the local corporate bond market’s absolute capac- ity to raise new capital are collected. This offers a flow measure of access to bond markets. Both the number and value of new corporate bond issues in domestic markets are available in FSDI annually for 2001-2005 for an exhaustive list of countries around the world. The data show that
corporations in high-income OECD countries ac- count for nearly 90% of the corporate bond issues globally. Corporate bond issues in developing countries are still small by global standards, as well as incommensurate with their rising share of production in the world economy.
2 7 12 17 22
High income:
OECD
High income:
Other
Low income
Lower middle income
Upper middle income Value of new corporate bonds to GDP, 2004
Percent
Private sector information
Information on private sector participants in bond markets is important from the following perspective:
• For the bond market to play an effective role in the growth of business, it has to be able to facilitate financing for both the corporate sector and the government.
• It reflects systematic progress in creditor protection, le- gal infrastructure etc., in a country, as the development of corporate bond markets requires more systematic progress than does the development of government bond markets (Claessens et al, 2005).
• It reflects facilitation of private credit. Heavy issuance of bonds by the government, coupled with regulations forc- ing banks to purchase and hold such securities, can result in financial repressions and crowding out of the private sector.
High income: OECD
High income: Other
Upper middle income
Lower middle income
Low income Value of new corporate bonds issues, 2004
89%
4% 2%
2%
3%
Efficiency
Efficiency of bond markets is as important as their size. More than 130 countries operate some form of organized bond market, but only about 50 have become substantial in size, and an even smaller number are efficient by international standards.
To measure the efficiency of bond markets, FSDI focuses on the liquidity of markets as reflected by the tightness of the quoted bid-ask spread and the turnover ratio. Substantial and adequate li- quidity enables markets to fulfill their roles in di- versifying risks, monitoring issuers, and allocat- ing resources for more productive purposes.
Quoted bid-ask spreads on government bond yields (as of March 2006) are obtained for a large cross-section of countries from major market- makers of sovereign bonds in developed and emerging markets. The following patterns are re- vealed:
• In European countries that have adopted the Euro as their currency, bid-ask spreads on bond yields are lower than one basis point, while in other countries with similar fundamentals, e.g., Sweden, traders have to pay substantially higher spreads.
• The bid-ask spreads on government securities of Asian emerging economies in general are be- tween 6-10 basis points and much below those for Latin American countries.
Tight Spread Wide Spread
USA Vietnam
Austria Peru
Germany Qatar
Belgium Dominican Republic
France Pakistan
Ranking of Countries by Bid-Ask Spreads
Quoted bid-ask spread worldwide (10-yr government bond yield; basis points)
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The data on turnover ratio (from WFE) for both private and public sector bonds traded on sec- ondary markets is another efficiency indicator.
However, these numbers do not include the many trades that settle outside the stock exchanges between, for example, financial institutions and over the counter markets.
Stability
Lack of stability in bond markets can contribute to a higher cost of capital and discourage investors from entering the markets. For example, high vola- tility in the price of benchmark government bonds hampers the development of yield curves and the adequate pricing of corporate bonds. Due to pau- city of high frequency data on corporate bonds, FSDI primarily focuses on government bonds.
Daily return index of sovereign bonds are collected from both Datastream (for developed economies) and Citibank (for mainly emerging markets). Based on the daily return indices, volatility (annualized standard deviation), skewness, maturity struc-
ture and correlation between bond returns are analyzed.
Volatility: This is the commonly used measure of stability. Analysis highlights that volatility in select developing countries is below that in developed markets. This maybe the outcome of (i) trading of bonds being less active in developing countries, and in many instances prices remain unchanged for several weeks; and (ii) interest rate regulation in some markets sometimes distorts the true cost of capital. As such, underestimation of instability in developing countries remains a distinct possi- bility.
Skewness: This indicator gauges the probability of large negative losses associated with countries’
sovereign bonds. Losses concern investors more than large surges of bond prices. As shown in the map (below), bond returns in developed markets in general exhibit less negative skewness, i.e., they are less likely to deliver large negative returns than those in developing countries.
Skewness of government bond returns
Maturity: A large share of short-term securities in total securities debt is an important sign for insta- bility and risk, as it heightens vulnerability to sud- den outflows of capital, or surges of short-term interest rate that can increase the burden of debt service.
Correlation: This refers to the correlation of a country’s bond returns with returns on U.S. or German (Euro) bonds. Lower correlation indicates higher diversification and therefore less cross- border synchronicity. The table above (right) shows that geographic proximity with the U.S. (and vice-versa Germany) results in higher correlation.
Composite Indicators
FSDI provides composite indicators for the dimen- sions of the bond market (size, access, efficiency and stability), as well as for their overall develop- ment. These composite indicators have been con- structed using the standardized methodology uti- lized in the FSDI framework.
Argentina 5.4
Aus tralia 45.0
France 31.4
Germ any 31.3
India 7.7
Indonesia 13.7
United Kingdom 40.7
United States 21.7
Short-term bond to total bond ratio (%)
US Euro
Canada 0.85 0.09
Chile 0.91 0.09
China 0.82 0.11
Mexico 0.64 0.18
Netherlands 0.58 0.43
United Kingdom 0.58 0.42
Correlation with US and Euro Bond Returns
Dimensions complimentary
Overall, the four dimensions of bond market de- velopment are positively correlated. Larger bond markets are more efficient and provide easier ac- cess to lower cost domestic capital. This rein- forces previous findings, such as those in McCauley and Remolona (2000), which suggest that a critical size of around $100-$200 billion is required to support a liquid market. Further, coun- tries that do well in size are also more stable.
Smaller markets are more volatile and closely cor- related with major developed markets, and in ad- dition the maturity structure of their debt is shorter.
The table on page 10 presents the composite bond
Creating composite indicators
The composite indicator for each of the various four dimension of capital markets is comprised of sub- indicators. These sub-indicators are standardized by subtracting the median of the distribution and scaled by the standard deviation of the distribution. These standardized scores are then averaged to create the composite indicator for each dimension.
Size
Stability
Efficiency
Access Composite Bond Market Indicators
USA
India
Brazil
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market indicators for the multidimensional system and the correlation between the four dimensions.
As an example of benchmarking all four dimen- sions, a comparison of Brazil, India and the U.S.
is presented in the radar chart (previous page).
The U.S. has the most developed bond market among the three countries, while India’s bond market is more stable than Brazil’s even though the latter has a larger bond market compared with the former.
The four-dimension analytical capacity provided by FSDI serves as a powerful mechanism for iden- tifying strengths and weaknesses in bond mar- kets and can be utilized effectively for the purposes of policy formulation and reforms.
Select References
Burger, John D., and Francis E. Warnock, 2005, “Foreign participation in local-currency bond markets,” Working Paper.
Clayton, Matthew J., Bjorn N. Jorgensen and Kenneth A.
Kavajecz, 2005, “On the presence and market-structure of exchanges around the world,” Journal of Financial Mar- kets, Vol.9(1): 27-48.
Claessens, Stijn, Daniel A. Klingebiel, Sergio L. Schmukler, 2005, “Government Bonds in Domestic and Foreign Cur- rency: The Role of Institutional Factors,” Review of Inter- national Economics.
McCauley, Robert and Eli Remolona, “Size and Liquidity of Government Bond Markets”, BIS Quarterly Review, Novem- ber 2000.
Data Sources Bloomberg
Bank of International Settlements (BIS) Datastream
Financial Structure Database, The World Bank Thomson Financial
World Federation of Exchanges (WFE)
Size Access Efficiency Stability
Size 1.00
Access 0.40* 1.00
Efficiency 0.46* 0.40* 1.00
Stability 0.05 0.09 -0.02 1.00
* indicates significance at the 5% level
Correlation matrix for composite indicators
Country Size Efficiency Access Stabilty Overall
DNK 7.92 8.33 6.46 3.96 6.67
JPN 8.76 5.99 5.98 5.04 6.44
USA 7.54 6.06 6.43 5.26 6.32
ISL 9.92 5.00 5.00 5.00 6.23
SWE 6.07 9.30 5.52 3.65 6.13
NLD 8.08 6.13 4.84 4.38 5.86
ITA 7.49 6.10 5.39 4.34 5.83
AUT 6.06 6.00 4.94 6.12 5.78
BEL 7.59 6.13 5.33 3.93 5.75
FRA 6.54 6.13 5.33 4.59 5.65
DEU 6.13 6.16 5.12 5.07 5.62
GRC 6.89 6.04 4.43 5.00 5.59
ESP 5.87 6.01 5.44 4.76 5.52
KOR 5.29 5.33 6.15 5.00 5.44
PRT 6.02 6.10 5.28 4.05 5.36
CHE 5.19 5.15 6.58 4.42 5.34
CAN 5.87 6.06 5.00 4.38 5.33
COL 4.36 7.41 4.03 4.70 5.12
POL 4.49 5.87 3.76 6.09 5.05
SGP 5.32 5.40 5.10 4.22 5.01
SVK 4.32 5.70 5.00 5.00 5.01
FIN 5.57 6.10 4.75 3.60 5.00
GBR 5.37 7.24 3.82 3.55 5.00
IRL 6.40 6.31 4.36 2.91 4.99
MYS 5.86 4.13 5.70 4.28 4.99
NOR 4.71 5.88 5.20 4.07 4.96
AUS 5.10 5.92 5.09 3.66 4.94
CZE 5.18 4.51 5.00 5.00 4.92
THA 4.45 4.51 5.53 5.00 4.87
HKG 4.33 4.71 5.19 5.00 4.81
CHL 4.68 4.08 5.55 4.82 4.78
ZAF 4.67 3.77 4.22 5.53 4.55
IND 4.35 4.53 4.26 5.00 4.54
ARG 4.35 4.99 3.54 5.00 4.47
RUS 3.48 4.69 5.00 4.55 4.43
NZL 4.30 5.00 5.00 3.15 4.36
HUN 5.01 3.12 3.52 5.38 4.26
IDN 4.10 3.47 4.61 4.26 4.11
MEX 4.17 4.14 3.09 4.47 3.97
TUR 5.09 4.16 3.20 3.35 3.95
PAK 4.39 1.94 5.00 4.07 3.85
BRA 5.16 3.12 3.10 2.83 3.55
PHL 4.57 2.79 2.18 4.57 3.53
PER 3.66 2.55 4.49 3.27 3.49
Bond Market Composite Indicators and Ranking
