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Journal of Emerging Market Finance
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Articles

Imperfect Information and Contagion in Capital Markets

A Test on Emerging Markets Sovereign Bonds

Philippe Dupuy

Philippe Dupuy, Ph D., Multi-Asset Fund Manager. I am grateful to Jyoti Gupta, Joël Metais, André Orléan and John Simpson for useful comments and suggestions. I am also indebted to Regis Chatellier for technical help. E-mail: Philippe.dupuy{at}cegetel.net

In this article, we test the importance of the role played by imperfect information in emerging markets sovereign bonds. We develop a model of secondary market bond spreads that incorporates measures of both risk and ambiguity created by imperfect information. We test it on a large set of emerging markets over a recent period by using bid and ask spreads as a proxy for the level of ambiguity in each market. We find strong evidence that ambiguity is a key element in sovereign spread determination in secondary markets. We also show that the concept of ambiguity is a good candidate for justifying contagion during a crisis. In particular, we are able to discriminate between crises that arose due to a global disturbance on perceived ambiguity from others.

Key Words: Imperfect information • contagion • sovereign debt • spread • ambiguity • JEL Classification: D82 • JEL Classification: G14

Journal of Emerging Market Finance, Vol. 7, No. 2, 103-140 (2008)
DOI: 10.1177/097265270800700201
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