How Do Official Bailouts Affect the Risk of Investing in Emerging Markets?

We analyze the effects of bailout expectations on sovereign bond spreads in emerging markets. The non-bailout of Russia in August 1998 is interpreted as an event that decreased the perceived probability of future crisis lending to emerging markets. If official rescues are expected to mitigate the losses of investors in the event of a crisis, such an event should raise the cross-country dispersion of spreads, because investors pay more attention to differences in risk characteristics across countries. We find strong evidence for such an effect. This is consistent with the existence of "investor moral hazard," at least prior to 1998.

University of Mainz Publication