What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?

This paper analyzes data on nearly one thousand developing country bonds issued during 1991-96, a period that spans the recent episode of heavy reliance on bonded debt. Both the issue decisions of debtors and the pricing decisions of investors are considered, minimizing the potential for selectivity bias. Overall, the results confirm that measures of higher credit quality lead to a higher probability of issue and to a lower spread. Observed changes in fundamentals, however, explain only a small portion of the spread compression in the period leading up to the recent crisis in emerging markets.