Mauricio Villamizar Villegas, Banco de la República (The Central Bank of Colombia)
Tomas Williams, George Washington University
Abstract: In emerging markets, higher bond term premia are typically accompanied by higher currency premia. We attribute this relationship to the prominent role of global investors in local-currency bond markets and their limited use of currency hedging. Using transaction-level data from Colombia’s bond and foreign exchange markets, we show that foreign investors’ bond trades are systematically accompanied by simultaneous transactions in the spot exchange market, but not in the forward exchange market. We incorporate these correlated flows into a portfolio-balance model that also accounts for short-term interest rate risk. The model helps explain cross-country differences in the comovement of bond yields and exchange rates, the observed patterns of positions and returns in bond and foreign exchange markets, and the effects of quantitative easing and foreign exchange interventions.
Discussant: Julie Zhiyu Fu, Washington University-St. Louis
Michele Dathan, Federal Reserve Board of Governors
Michael Young, University of Missouri
Qifei Zhu, National University of Singapore
Abstract: Misspecified benchmarks are prevalent among active bond mutual funds, due in part to the industry’s overreliance on the low-risk Bloomberg U.S. Aggregate Index. Active funds outperform their benchmarks by 3% over 36 months, but this is driven by the selection of benchmarks with mismatched systematic risks, not managerial skill. When matched to a more appropriate benchmark based on return correlations, funds actually underperform. Benchmark-adjusted returns drive future flows providing incentives for managers to misbenchmark. While benchmark changes are infrequent, they are strategic: funds switch to easier-to-beat benchmarks following a period of underperformance and subsequently experience a short-term increase in flows.
Discussant: Kevin Mullally, University of Central Florida
Abstract: We examine cross trading by mutual funds in corporate bonds. We find that crosstrading is relatively common in the 2008 to 2023 sample period, with substantialvariation across fund families and greater activity for illiquid and hard-to-obtain bonds.Cross trading is particularly elevated around maturity cutoffs, credit rating changes,and periods of extreme fund flows, suggesting that it can be beneficial in times of stress.High-fee funds tend to cross with lower-fee funds, but we find no evidence that crossingtransfers performance from low- to high-value funds. We document large transactioncost savings, although these savings have diminished following a regulatory change thatsignificantly limits cross trading.
Discussant: Russell Wermers, University of Maryland
