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Bank for International Settlements (BIS)

Investment Banks’ Recommendations

and Emerging Markets: The Usual Suspects

Basel - September

2007

Javier Santiso

Chief Economist and Acting Director

Sebastian Nieto Parra

Research Associate

OECD Development Centre

2

ObjectiveObjective11

Capital Flows and Research PublicationsCapital Flows and Research Publications22

Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations33

Overview

Conclusions and Policy LessonsConclusions and Policy Lessons44

3

Two core questions

• Do recommendations given by investment banks have an impact on the allocation of portfolio flows in the emerging markets?

• What is behind investment banks’ recommendations? A work in process:

- Recommendations and the business of investment banks (i.e. bond issuances by sovereigns).

- Financial Markets’ analysts and political events in emerging democracies.

4


Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations

22 Capital Flows and Brokers PublicationsCapital Flows and Brokers Publications

33

Overview


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Recommendations Database

• Construction of a unique database containing the recommendations given by the major investment banks to the Latin American bond markets:

- Over 3 800 observations.

- 12 Major Investment Banks.

- Covering the period 1997-2007.

- Direct and strict link between financial intermediaries and investors (not public information).

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• We have taken the recommendations given by 12 investment banks. All of them important players in the emerging bond markets, i.e. market makers.

Institution Name of the Publication Periodicity Start Date

ABN AMRO Emerging Markets Fortnightly Bi-weekly Jan-04

Barclays Capital LatAm Drivers Fortnightly Bi-weekly Feb-04

Bear Stearns Emerging Markets Sovereign Journal Weekly Weekly Feb-06

Citigroup (Citi-Salomon Brothers) Economics/Strategy Monthly Jul-97

Credit Suisse (CSFB) Debt Trading Monthly Monthly May-01

Deutsche Bank Emerging Markets Monthly Monthly Sep-01 to Dec-05

Dresdner Kleinwort Wasserstein EM Strategist Monthly Jan-04

Goldman Sachs Emerging Markets Strategy Bi-Weekly Aug-01 to Aug-03

JP Morgan Emerging Markets Outlook and Strategy Monthly Jan-01

Lehman Brothers Emerging Markets Compass Bi-Weekly Sep-04

Merrill Lynch Emerging Markets Debt Monthly Monthly Feb-03

Morgan Stanley EMD Perspectives Quarterly Quarterly 1Q-00

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Example: Average of the recommendations given to Brazil by the investment banks (lhs) with respect to the weight of Brazil in the EMBI Global index (rhs).

Brazil: Sovereign Bond Index Weight (%, EMBI Global)

10

15

20

25

30

J ul-97 J ul-98 J ul-99 J ul-00 J ul-01 J ul-02 J ul-03 J ul-04 J ul-05 J ul-06

Source:The authors from J P Morgan, 2007

Brazil: Recommendations(1:overweight, 0:neutral, -1:underweight)

-1,00

-0,50

0,00

0,50

1,00

J ul-97 J ul-98 J ul-99 J ul-00 J ul-01 J ul-02 J ul-03 J ul-04 J ul-05 J ul-06

Source:The authors from investment banks' publications, 2007

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We have taken 11 Latin American countries that represent nearly 95% of the GDP of the region.

The total number of recommendations is over 3,800.

ABN BARC. BS CITI CSFB DB DK GS JPM LB ML MS TOTALArgentina 11 3 14 86 65 50 8 24 67 18 25 24 395

Brazil 11 13 15 89 66 50 8 25 67 18 33 24 419Chile 11 13 6 87 65 0 0 25 64 18 0 0 289

Colombia 11 13 15 88 65 50 8 25 67 18 32 24 416Dominican Rep 0 0 12 17 1 0 0 2 58 0 10 16 116

Ecuador 1 13 15 88 60 50 8 25 66 18 33 24 401Mexico 11 13 14 89 66 50 8 25 67 18 33 24 418Panama 0 13 9 68 62 50 8 25 67 0 33 24 359

Peru 1 13 14 89 65 50 8 25 67 18 33 24 407Uruguay 0 0 12 22 58 0 0 16 61 18 10 0 197

Venezuela 11 12 13 90 61 50 8 25 67 18 33 24 412TOTAL 68 106 139 813 634 400 64 242 718 162 275 208 3829

Part. Underwriting 4% 3% 2% 10% 5% 11% 2% 10% 23% 0% 7% 10% 87%

Source: The authors from investment banks' publications (for recommendations) and Dealogic (for underwriting),2007

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Capital Flows to Emerging Countries

• A large body has studied the determinants of capital flows:

“Push factors” or global factors. Fernandez-Arias (1996) and Calvo et al (1993).

“Pull factors” or local factors.Taylor and Sarno (1997) and Alfaro et al (2005).

Information and distance.Savastano (2000), Papaioannou (2004) and Portes and Rey

(2005).

11

Determinants of capital flows

• Impact of recommendations on capital flows (Bond flows and Equity flows respectively):

(i) (ii)

where and : percentage allocated by funds in country i with respect to the total amount invested in emerging economies.

: the average of the investment banks’ recommendations given to country i.

: Pull macroeconomic variables defined by capital markets (exchange rate, spread of sovereign bonds and rate of return of equity).

ittitititit PushalMarketcBond ReRe

ittitititit PushalMarketcEquity ReRe

itBond itEquity

itcRe

itMarket

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: Pull macroeconomic variables that are strongly influenced by real sector (economic activity, inflation rate and interest rate).

: country invariant variables which capture global factors (US nominal rates and US industrial production).

• Period of the analyses: 1997-2005 for equity flows 2002-2006 for bond flows

• Frequency: Monthly.

• Countries: Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.

tPush

italRe

13


• We used Variance Inflation Factors (VIF) as a measure of the multi-colinearity in the regressions. The result of this analysis excluded two variables:

- US Federal Funds Real rate (by substracting core CPI)

- A Composite leading indicator (CLI) provided by the OECD.

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• In order to determine if a Random Effects Model (REM) was an adequate econometric model for this analysis we realised the Hausman Test. The null hypothesis underlying the Hausman Test (FEM and REM estimators do not differ substantially) was rejected.

• In order to avoid problems of endogeneity between independent and dependent variables we have also taken into account the first lag of each of the explanatory variables in the regressions. In fact, by taking the lagged explanatory variable we could solve causality problems which are common to capital flows analysis.

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Determinants of bond flowsDependent variable: Bond

I II III IV V VI VII VIII IX X XI XIIRecommendations 1.112*** 1.120***

(8.08) (8.35)Exchange Rate (Market ) 0.001*** 0.002*** 0.002*** 0.003***

(4.0) (5.1) (5.21) (7.23)Spread (Market ) -0.078*** -0.103*** -0.066*** -0.093***

(-9.48) (-12.24) (-9.25) (-13.17)Stock (Market ) -0,0004 -0,0014 0.0022* 0,0018

(-0.27) (-0.81) (1.77) (1.35)Inflation rate (Real ) 0.021** 0,016 0,007

(2.14) (1.47) (0.6)Economic Activity (Real ) 0.033*** 0.035*** 0.036***

(3.25) (3.08) (3.08)Interest rate (Real ) 0,009 0,000 -0.034***

(1.22) (0) (-3.87)US interest rate (Push) -0.186*** -0.288*** 0,071

(-2.83) (-4.05) (0.83)US ind. production (Push) -0.051* -0.072** -0,044

(-1.66) (-2.11) (-1.08)Recommendations -1 1.062*** 1.095***

(7.47) (7.89)Exchange Rate -1 (Market ) 0.001*** 0.002*** 0.002*** 0.003***

(4.07) (5.22) (5.22) (7.18)Spread -1 (Market ) -0.072*** -0.096*** -0.062*** -0.088***

(-8.01) (-10.38) (-7.79) (-11.26)Stock -1 (Market ) -0,002 -0.004** 0,002 0,002

(-1.35) (-2.01) (1.51) (1.19)Inflation rate -1 (Real ) 0.024** 0.024** 0,009

(2.45) (2.24) (0.75)Economic Activity -1 (Real ) 0.034*** 0.037*** 0.039***

(3.1) (3.14) (3.42)Interest rate -1 (Real) 0,005 -0,005 -0.034***

(0.64) (-0.65) (-3.9)US interest rate -1 (Push) -0.173** -0.254*** 0,036

(-2.45) (-3.35) (0.44)US ind. production -1 (Push) 0,026 0,023 0.123***

(0.8) (0.64) (3.09)Cons 5.634*** 6.188*** 6.264*** 6.332*** 5.539*** 5.393*** 5.376*** 5.687*** 5.921*** 6.286*** 5.472*** 5.332***

(12.23) (12.35) (24.55) (18.71) (22) (19.44) (13.62) (13.34) (33.97) (19.35) (21) (18.76)

N (Observations) 322 322 322 322 322 322 322 322 322 322 322 322

Adjusted R-squared 0,57 0,48 0,01 0,16 0,54 0,44 0,52 0,43 0,03 0,17 0,49 0,39

t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.

FIXED EFFECTS (2002 - 2005)

16

Determinants of equity flowsDependent variable: Equity

I II III IV V VI VII VIII IX X XI XIIRecommendations 0.518*** 0.579***

(5.9) (6.07)Exchange Rate (Market ) 0,0002 0.0005*** -0.0005*** -0.0004**

(1.18) (2.58) (-3.01) (-2.34)Spread (Market ) -0.031*** -0.034*** -0.036*** -0.043***

(-5.44) (-5.6) (-6.88) (-7.89)Stock (Market ) 0.0039** 0.0055*** -0,0009 0,0003

(2.57) (3.61) (-0.74) (0.26)Inflation rate (Real ) 0.013** 0,007 -0,005

(2.33) (1.26) (-1.05)Economic Activity (Real ) 0,006 0,007 0.022**

(0.67) (0.79) (2.36)Interest rate (Real ) 0.024*** 0.025*** 0.018***

(3.83) (3.91) (2.96)US interest rate (Push) 0.307*** 0.34*** 0.345***

(10.39) (11.26) (14.34)US ind. production (Push) -0.039** -0.045** -0,009

(-2.16) (-2.41) (-0.56)Recommendations -1 0.58*** 0.640***

(6.67) (6.72)Exchange Rate -1 (Market ) 0,0002 0.0006*** -0.0006*** -0.0004**

(1.14) (2.7) (-3.06) (-2.43)Spread -1 (Market ) -0.032*** -0.033*** -0.035*** -0.042***

(-5.57) (-5.50) (-6.71) (-7.86)Stock -1 (Market ) 0,002 0.004*** -0,001 0,001

(1.37) (2.6) (-0.62) (0.90)Inflation rate -1 (Real ) 0.016*** 0.009* -0,004

(2.92) (1.73) (-0.81)Economic Activity -1 (Real ) 0,011 0,010 0.027***

(1.24) (1.14) (2.99)Interest rate -1 (Real) 0.027*** 0.026*** 0.021***

(4.33) (4.06) (3.46)US interest rate -1 (Push) 0.287*** 0.323*** 0.308***

(9.25) (10.06) (11.9)US ind. production -1 (Push) 0,015 0.027* 0.057***

(0.98) (1.65) (3.86)Cons 1.729*** 1.717*** 2.243*** 3.303*** 3.970*** 4.083*** 1.570*** 1.540*** 2.195*** 3.216*** 3.939*** 4.071***

(8.09) (7.8) (20.65) (19.94) (33.56) (34.99) (7.55) (7.17) (22.64) (19.55) (33.41) (35.17)

N (Observations) 657 691 721 714 660 698 650 689 721 713 653 697

Adjusted R-squared 0,32 0,28 0,23 0,01 0,13 0,09 0,33 0,29 0,25 0,02 0,14 0,09

t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.

FIXED EFFECTS (1997 - 2005)

17


Three results:

1. The impact of investment banks’ recommendations on capital flows is positive and significant.

2. The impact of the recommendations given to external public debt goes beyond sovereign bond flows. Indeed, although their influence is minor, these recommendations also affect private equity flows.

3. This new microeconomic variable improves the fit of capital flows regressions more than some traditional macroeconomic variables such as interest rates, economic growth and inflation rate.

18



22 Capital Flows and Brokers PublicationsCapital Flows and Brokers Publications

33

Overview


19

Recommendations and Research Literature

Variety of results:

- Analysts are confronted with a trade-off between sending true signals and optimistic signals. Jackson (2005).

- Larger number of buy recommendations than sell recommendations. Barber et al (2001).

- Market reaction to upgrades is less pronounced than the market reaction to downgrades by analysts. Asquith et al (2005).

- Impact of the measures introduced by the NYSE and NASDAQ, but also the sanctions established by the SEC in 2002. Madureira (2004), Boni and Womack (2002) and Unger (2001).

20

Recommendations and Research Literature

• Empirical studies of the relationship between the recommendations and underwriters are concentrated to OECD countries. Agrawal et al (2008), Lin et al (1998), Krigman et al (2001), Dechow et al (2000) and Michaely and Womack (1999).

• Research literature concentrated in emerging markets is scarce and exclusively concentrated in the equity market. Bacmann and Bollinger (2001), Seasholes (2000 and 2004) and Chang et al (2000).

21

Investment banks’ business

• Banks are faced with a trade-off concerning recommendations: - While sell side business could have the incentive to build

reputation by giving accurate information in the long term ….

- …. in the short term recommendations could be biased in order to obtain short term profits.

- Additionally, investment banking activities could be motivated to recommend optimistically the assets which they are participating as underwriters in an IPO.

22

Underwriters’ recommendations

- 90% of the underwriters recommend at the issue date to buy or to maintain in their portfolio the bonds issued by the countries where they are acting as underwriters.

Underwriters' recommendations (Announcement date of the issue)Jan. 1999 - Feb 2007

OVER. (%) NEUTRAL (%) UNDER. (%) # ISSUESArgentina 0,0 66,7 33,3 9Brazil 58,0 42,0 0,0 38Chile 20,0 60,0 20,0 5Colombia 37,5 62,5 0,0 32Dom. Rep. 0,0 100,0 0,0 2Ecuador 50,0 50,0 0,0 2Mexico 29,0 54,8 16,1 31Panama 0,0 71,4 28,6 14Peru 46,2 38,5 15,4 13Uruguay 0,0 100,0 0,0 1Venezuela 66,7 26,7 6,7 15TOTAL 38,0 52,0 10,0 162Source: The authors from Investment Banks' recommendations and Bloomberg, 2007

23

Size of the Market and Recommendations

As the size of the market increases, the recommendation tends to become increasingly favourable: “too big to underweight”.

Average Recommendation EMBI-Global country weights EMBI-Global spreads (1:over; 0:neutral; -1:under.) (%) Basis Points (bp)

Argentina -0,14 11,1 2536,7Brazil 0,35 19,3 774,9Chile 0,00 1,0 139,1Colombia 0,12 2,2 496,1Dom. Rep. -0,01 0,3 656,4Ecuador -0,03 1,3 1391,6Mexico 0,29 16,8 342,0Panama -0,03 1,9 376,4Peru 0,05 1,7 486,5Uruguay -0,32 0,7 609,5Venezuela 0,16 5,3 798,7Correlation with recomm. (with Argentina) 0,65 -0,30Correlation with recomm. (without Argentina) 0,81 -0,04Source: The authors, from Investment banks' publications and JP Morgan, 2007

Recommendations vs. Credit Risk and Size of the Countries (Average 1997-2006)

24

The Argentinean Case67 per cent of the recommendations were to maintain the positions in

Argentinean External Debt (prior 2001). Two examples:

Morgan Stanley: “We are maintaining our Market Perform recommendation on Argentine bonds….Relaxation of fiscal targets and an innovative IMF-led financial package from creditors both improve Argentina’s credit outlook. Argentina needs to raise an estimated $2.6 billion to fulfil its first quarter financing requirements. New issues are expected to total $5.6 billion in 2001. Growth and fiscal performance are becoming the focus of investors’ attention.” January 26, 2001.

Salomon Smith Barney (Citigroup): “The successful implementation of the IMF support package — with the associated debt management transactions — and the change in the global outlook probably increases the chances that economic activity will pick up in the second half of the year. We therefore recommend a neutral position in external bonds and local currency instruments.” January 17, 2001 .

25

Underwriters’ Recommendations

Structure of the Underwriting Market: Few number of participants.

# Issues ABN BARCLY. CITI CSFB DB GS JPM ML MS UBS TOTALArgentina 53 1,0 1,4 7,7 9,9 17,3 6,2 19,2 2,3 17,6 0,0 82,7Brazil 57 0,9 0,4 10,9 4,2 9,4 12,0 16,9 9,1 12,9 5,1 81,7Chile 7 0,0 0,0 31,2 0,0 25,1 0,0 37,0 6,7 0,0 0,0 100,0Colombia 45 3,8 0,0 13,9 11,4 3,8 13,4 22,1 11,8 11,6 4,8 96,6Dom. Rep. 3 0,0 0,0 21,4 0,0 0,0 0,0 50,0 0,0 28,6 0,0 100,0Ecuador 1 0,0 0,0 0,0 0,0 50,0 0,0 50,0 0,0 0,0 0,0 100,0Mexico 35 0,0 6,0 9,9 7,1 4,9 17,1 28,7 1,0 12,1 4,1 90,9Panama 12 0,0 0,0 39,9 0,0 5,0 3,5 16,9 0,0 34,6 0,0 100,0Peru 11 0,0 0,0 24,0 4,8 13,5 0,0 41,8 4,8 3,8 7,2 100,0Uruguay 23 1,3 0,0 22,3 6,2 16,7 0,0 11,9 10,7 7,1 19,5 95,7Venezuela 17 20,6 3,4 2,9 20,6 14,0 0,0 14,9 3,4 0,0 9,7 89,5Source: The authors from Bloomberg and Dealogic, 2007

Participation (%) of the underwriters in Latin American Countries (Jan. 1999-April 2007)

26


The probability that a government continues at state t+1 with the same lead manager used in the previous period (t) is reduced.

ABN BARCLY. CITI CS DB GS JPM ML MS UBS Nomura DrKW Finantia Millen. HSBC UniC. ING BNP. BS Total ABN 0,0 0,0 0,0 0,0 0,0 0,0 50,0 33,3 16,7 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100

BARCLY. 0,0 0,0 0,0 0,0 16,7 0,0 16,7 0,0 0,0 33,3 0,0 0,0 0,0 0,0 16,7 0,0 0,0 16,7 0,0 100CITI 0,0 0,0 4,5 13,6 4,5 18,2 13,6 27,3 4,5 4,5 0,0 4,5 0,0 0,0 4,5 0,0 0,0 0,0 0,0 100CS 5,3 0,0 5,3 0,0 10,5 10,5 5,3 5,3 5,3 5,3 0,0 10,5 0,0 0,0 0,0 21,1 0,0 10,5 5,3 100DB 0,0 11,1 7,4 7,4 3,7 11,1 18,5 3,7 3,7 7,4 7,4 14,8 0,0 0,0 3,7 0,0 0,0 0,0 0,0 100GS 9,4 4,7 0,0 4,7 18,8 3,1 10,9 14,1 17,2 3,1 0,0 9,4 0,0 0,0 0,0 0,0 0,0 0,0 4,7 100

JPM 2,5 2,5 7,6 10,2 12,7 5,1 9,3 12,7 10,2 6,8 10,2 2,5 0,0 0,0 2,5 0,0 0,0 2,5 2,5 100ML 3,8 3,8 11,5 0,0 23,1 6,4 2,5 3,8 17,9 3,8 15,4 3,8 0,0 0,0 0,0 0,0 0,0 0,0 3,8 100MS 0,0 0,0 4,7 4,7 4,7 9,4 12,5 14,1 9,4 12,5 9,4 14,1 0,0 0,0 0,0 0,0 0,0 4,7 0,0 100UBS 0,0 11,1 11,1 11,1 11,1 11,1 16,7 0,0 0,0 5,6 11,1 11,1 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100

Nomura 0,0 0,0 25,0 16,7 0,0 0,0 8,3 0,0 8,3 0,0 0,0 16,7 8,3 8,3 0,0 0,0 0,0 0,0 8,3 100DrKW 4,5 0,0 4,5 0,0 9,1 0,0 13,6 9,1 4,5 4,5 27,3 4,5 0,0 0,0 4,5 0,0 0,0 13,6 0,0 100

Finantia 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 0,0 0,0 0,0 100Millen. 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 0,0 0,0 0,0 100HSBC 0,0 0,0 10,0 10,0 0,0 10,0 40,0 10,0 0,0 20,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100

UniCredit 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 0,0 100ING 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100,0 0,0 100BNP. 0,0 0,0 0,0 0,0 41,7 16,7 33,3 0,0 0,0 8,3 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,0 100BS 0,0 0,0 16,7 0,0 0,0 16,7 16,7 16,7 0,0 0,0 0,0 16,7 0,0 0,0 16,7 0,0 0,0 0,0 0,0 100

Source: The author based on Dealogic, 2007

where: ABN is ABN AMRO, BARCLY is Barclays Capital, BS is Bear Stearns, CITI is Citigroup, CS is Credit Suisse, DB is Deutsche Bank, DrKW is Dresdner Kleinwort Wasserstein, GS is Goldman Sachs, JPM is JP Morgan, ML is Merrill Lynch, MS is Morgan Stanley, Millen. is Millennium BNP. is BNP Paribas and UniC is Unicredit Group.

Lead Managers´ Transition Matrix (%) Brazilian Case (May 1995-Dec. 2006)

27


Given the structure of the market, there is an incentive for non-underwriters to give an equal or better recommendation than underwriters.

Underwriters vs No-Underwriters' recommendations (Announcement date, Average 1999-2006)

-0,6

-0,4

-0,2

0

0,2

0,4

0,6

0,8

Arg

.

Bra

zil

Chi

le

Col

ombi

a

Dom

. R

ep.

Ecu

ador

Mex

ico

Pan

ama

Per

u

Uru

guay

Ven

ez.

Tot

. A

ver.

Wei

gth.

Ave

r.

Source: The authors, 2007

Underw riter

No underw riter

28


A possible variable that represents the conflict of interest of banks could be the countries’ participation in the banks’ primary bond markets business (by using a long run analysis). Two years…

Countries Participation in JP Morgan's Latam Primary Bond Market Business (%) (during the last 2 years)

0

10

20

30

40

50

60

70

80

Jul-9

7

Jul-9

8

Jul-9

9

Jul-0

0

Jul-0

1

Jul-0

2

Jul-0

3

Jul-0

4

Jul-0

5

Jul-0

6

Source: The authors based on Dealogic, 2007

Argentina Brazil

Colombia Mexico

Venezuela

Countries Participation in Merrill Lynch's Latam Primary Bond Market Business (%) (during the last 2 years)

0

10

20

30

40

50

60

70

80

90

100

Jul-9

7

Jul-9

8

Jul-9

9

Jul-0

0

Jul-0

1

Jul-0

2

Jul-0

3

Jul-0

4

Jul-0

5

Jul-0

6


Argentina Brazil

Chile Colombia

Mexico

29


3 years…

Countries Participation in Citibank's Latam Primary Bond Market Business (%) (during the last 3 years)

0

10

20

30

40

50

60

70

Jul-9

7

Jul-9

8

Jul-9

9

Jul-0

0

Jul-0

1

Jul-0

2

Jul-0

3

Jul-0

4

Jul-0

5

Jul-0

6


Argentina Brazil

Chile Colombia

Mexico

Countries Participation in Deutsche Bank's Latam Primary Bond Market Business (%) (during the last 3 years)

0

10

20

30

40

50

60

70

80

90

Jul-9

7

Jul-9

8

Jul-9

9

Jul-0

0

Jul-0

1

Jul-0

2

Jul-0

3

Jul-0

4

Jul-0

5

Jul-0

6


Argentina Brazil

Chile Mexico

Venezuela

30


…and 4 years. Moreover, some investment banks have specialized the origination business in small countries.

Countries Participation in Bear Stearns's Latam Primary Bond Market Business (%) (during the last 4 years)

-

10

20

30

40

50

60

70

80

90

100

Aug

-00

Aug

-01

Aug

-02

Aug

-03

Aug

-04

Aug

-05

Aug

-06


Barbados

Brazil

Grenada

J amaica

Mexico

Countries Participation in Morgan Stanley's Latam Primary Bond Market Business (%) (during the last 4 years)

0

10

20

30

40

50

60

70

80

90

100

Feb

-98

Feb

-99

Feb

-00

Feb

-01

Feb

-02

Feb

-03

Feb

-04

Feb

-05

Feb

-06


Argentina Brazil

Colombia Mexico

Panama

31

Political and Financial Crisis

Nominal exchange rate depreciation

and government change

0,94

0,96

0,98

1

1,02

1,04

1,06

1,08

1,1

1,12

1,14

1,16

-9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9

Source: Frieden, Ghezzi y Stein, 2001

Country`s Total Elections 1 Colombia 13 1989 172 Costa Rica 11 1990 143 Guatemala 11 1991 34 Ecuador 10 1992 05 Chile 10 1993 106Peru 10 1994 187 Honduras 10 1995 68 Paraguay 9 1996 89Brazil 9 1997 7

10 El Salvador 9 1998 1511Republica Dom. 9 1999 1212 Uruguay 9 2000 1113Mexico 9 2001 414 Argentina 8 2002 1315 Nicaragua 8 2003 816Panama 8 2004 617 Venezuela 8 2005 518 Bolivia 7 2006 11

32


Some countries achieved to decouple both cycles: Mexico in 2000.

-30

-20

-10

0

10

20

30

40

50

60

70

01/0

1/19

75

01/1

0/19

76

01/0

7/19

78

01/0

4/19

80

01/0

1/19

82

01/1

0/19

83

01/0

7/19

85

01/0

4/19

87

01/0

1/19

89

01/1

0/19

90

01/0

7/19

92

01/0

4/19

94

01/0

1/19

96

01/1

0/19

97

01/0

7/19

99

01/0

4/20

01

Source: Jorge Blázquez and Javier Santiso, 2004.

Timing of Presidential Elections and Exchange Timing of Presidential Elections and Exchange Rate Depreciations in Mexico, 1975-2000Rate Depreciations in Mexico, 1975-2000

Election Year

Election Year

Election Year

Election Year

Election Year

33


Others have overcome the test of fire more recently: Brazil in 2006

20%

25%

30%

35%

40%

45%

-180

-80

20

120

220

320

420

520

bp

Voter intention for Lula in the opinion polls

(left)

Spread Brazil-Emerging Countries and Electoral Polls1994

20%

22%

24%

26%

28%

30%

32%

-100

-50

0

50

100

150

200

pb.


(left)

Spread Brazil-Emerging Countries and Electoral Polls1998

Source: Based on Juan Martínez and Javier Santiso,

2003.20%

25%

30%

35%

40%

45%

0

200

400

600

800

1000

1200

1400


(left)

bp.Spread Brazil-Emerging Countries and Electoral Polls2002

Source: Datafolha, JP Morgan

34

Political Events and Bond Recommendations

Over the course of 2006, all the most important Latin American Countries (by excepting Argentina) elected their head of the state.

Country Date First/Second Round

Venezuela December 3, 2006

Ecuador November 26, 2006 Second round

Nicaragua November 5, 2006

Brazil October 29, 2006 Second round

Ecuador October 15, 2006 First Round

Brazil October 1, 2006 First Round

Mexico July 2, 2006

Peru June 4, 2006 Second round

Colombia May 28, 2006

Peru April 9, 2006 First Round

Haiti February 7, 2006

Costa Rica February 5, 2006

Chile January 15, 2006 Second roundSource: The authors, 2007

Presidential Elections Date (2006)

35


In comparison to previous election periods, the elections of 2006 point to a markedly improved confidence.

Latin America: recommendations(1:overweight, 0:neutral, -1:underweight)

-1.00

-0.50

0.00

0.50

1.00

J an-98 J an-99 J an-00 J an-01 J an-02 J an-03 J an-04 J an-05 J an-06 J an-07


Simple Average

Weighted Average

36


The Brazilian Case (2002 vs. 2006): “Da Lula Preta (2002)…

Brazil Presidential Election Day 0 = 27 Oct 2002

1000

1200

1400

1600

1800

2000

2200

2400

2600

-100 -75 -50 -25 0 25 50 75 100

Source: Thomson Financial Datastream, The authors, 2007

90

100

110

120

130

140

150

Sovereign Bond Spread (lhs.)

Exchange Rate (basis 100=-100)

First Round Second Round

Brazil: recommendations(1:overweight, 0:neutral, -1:underweight)

-1,00

-0,50

0,00

0,50

1,00

J ul-97 J ul-98 J ul-99 J ul-00 J ul-01 J ul-02


Presidential election date

37


The Brazilian Case (2002 vs. 2006).

…A Lula de Mel” (2006). An Ex-Emerging Market?

Brazil: recommendations(1:overweight, 0:neutral, -1:underweight)

-1,00

-0,50

0,00

0,50

1,00

J an-02 J an-03 J an-04 J an-05 J an-06 J an-07



Brazil Presidential Election Day 0 = 29 Oct 2006

150

200

250

300

-100 -75 -50 -25 0 25 50 75 100


90

92

94

96

98

100

102

104



Second RoundFirst Round

38


Chile: Political event is not an issue. An Ex-Emerging Market? During the presidential elections of 2000 and…

Chile: recommendations(1:overweight, 0:neutral, -1:underweight)

-1,00

-0,50

0,00

0,50

1,00

J ul-97 J ul-98 J ul-99 J ul-00 J ul-01


Presidential election dateChile Presidential Election Day 0 = 16 Jan 2000

50

100

150

200

250

300

-100 -75 -50 -25 0 25 50 75 100


80

85

90

95

100

105

110

Sovereign Bond Spread (lhs.)Exchange Rate (basis 100=-100)

Second RoundFirst Round

39

Political Events and Bond RecommendationsChile: Political event is not any more an issue

… the Presidential elections of 2006.

Chile: recommendations(1:overweight, 0:neutral, -1:underweight)

-1,00

-0,50

0,00

0,50

1,00

J ul-01 J ul-02 J ul-03 J ul-04 J ul-05 J ul-06


Presidential election dateChile Presidential Election Day 0 = 15 Jan 2006

0

25

50

75

100

-100 -75 -50 -25 0 25 50 75 100


80

85

90

95

100

105


Second Round

First Round

40

Political Events and Recommendations

Mexico: A risk country before the election date. In 2000 due to the risk of transparency of the election process.

Mexico: recommendations(1:overweight, 0:neutral, -1:underweight)

-1,000

-0,500

0,000

0,500

1,000

J ul-97 J ul-98 J ul-99 J ul-00 J ul-01


Presidential election dateMexico Presidential Election Day 0 = 2 Jul 2000

270

320

370

420

-100 -75 -50 -25 0 25 50 75 100


95

97,5

100

102,5

105

107,5

110


Election date

41


Mexico: A risk country before the election date.

In 2006 due to the risk of AMLO (López Obrador).

Mexico Presidential Election Day 0 = 2 Jul 2006

110

135

160

-100 -75 -50 -25 0 25 50 75 100


98

100

102

104

106

108

110



Election date

Mexico: recommendations(1:overweight, 0:neutral, -1:underweight)

-1,000

-0,500

0,000

0,500

1,000

May-02 May-03 May-04 May-05 May-06



42


Are financial markets becoming less sensitive to Latin American

Election Cycles? Probably YES, although Ecuador...

Risk

From beginning 2000's

t - 1 To 2006

Ecd. 06

No Risk Risk

t + 1

Br. 06 Ch. 06 Col. 06 Ven. 06

Peru. 06 Mex. 06

Br. 02 Col. 02 Ecd. 02 Peru. 01Mex. 00

Ch. 00Ven. 00

43

A work in process

An ordered probit analysis that determine the explanatory variables of recommendations. This model could be composed by three set of variables:

Where the investment value is given by the information ratio or Sharpe ratio:

)(/)( ,,,, tMtitMti rrrr

)_,_,__(Re 32,148,, tttttji valueinvestmentdatapoliticalmacroeresttinofconflictfc

44



22 Capital Flows and Research PublicationsCapital Flows and Research Publications

33

Overview


45

Investment banks’ recommendations

1. The impact of investment banks’ recommendations on capital flows is positive and significant.

2. What are the determinants of investment banks’ recommendations? Investment banks’ business and political events could be important factors.

An ordered probit regression analysis is necessary.

46

Policy Lessons

1. There is a need for more detailed information disclosure by investment banks : Push for financial markets transparency.

2. Government agencies should do a strategic monitoring on what financial market are writing about their respective country vulnerabilities: Monitor markets cognitive regimes.

3. Given that banks’ recommendations and portfolio flows are related, an international co-operation scheme needs to be established to encourage Market Makers to cover more countries: A Public –Private Patnership in emerging markets finance?

47

Policy Lessons

-

20

40

60

80

100

Arg

entin

aB

razi

lC

olom

bia

Mex

ico

Per

u V

enez

uela

Indo

nesi

aR

ussi

a

Tur

key

Phi

lippi

nes

Chi

le

Sou

th A

fric

aP

olan

dE

cuad

or

Hun

gary

Uru

guay

Chi

na

Mal

aysi

aS

outh

Kor

ea

Tha

iland

Egy

pt

Indi

a

Ukr

aine

Pan

ama

Bul

garia

Tai

wan

Ser

bia

Hon

g K

ong

Cze

ch R

ep.

Sin

gapo

reV

ietn

am

Rom

ania

S

lova

kia

Isra

el

Leba

non

Mor

occo

Nig

eria

T

unis

iaD

omin

ican

Rep

.

Alg

eria

Côt

e d'

Ivoi

re

Pak

ista

n

Emerging Markets Covered by Financial Institutions in 2006 (% of total brokers)

• Note: Countries most frequently analysed by Emerging Markets Analysts or covered by leading financial institutions. The percentage represents the average presence in their analysis. Only countries analysed by more than 25 per cent of the selected financial reports appear on the graph.

• Source: Nieto and Santiso (2007), calculation according to 10 selected investment banks 3 relevant emerging market indices 1 global association of financial Institutions.

48

Thank you!

Presentation based on:

Nieto Parra and Santiso (2007). “The Usual Suspects: A Primer on Investment Banks’ Recommendations and Emerging Markets”. OECD Development Centre Working Paper, 258 .

Nieto Parra and Santiso (2007). “Enter the Matrix: Wall Street and Elections in Emerging Democracies”. OECD Development Centre Working Paper, Forthcoming.

http://www.oecd.org/dev

Bank for International Settlements (BIS)

Investment Banks’ Recommendations

and Emerging Markets: The Usual Suspects

Basel - September

2007

Javier Santiso

Chief Economist and Acting Director

Sebastian Nieto Parra

Research Associate

OECD Development Centre