The Relationship Between Domestic Financial Development And Government Bond Returns: Cross-Country Evidence

This report is focused on the relationship which exists among domestic financial development and government bonds. For this study, cross country evidence has been used for analysing the proposed relationship. The first research question which is developed for this study is what is the relationship between domestic financial development and the return in sovereign bonds across various economies and the second research question is how does the relationship between financial development and returns in sovereign bonds compare between various groups of economies (the developed and developing economies). This report has designed the research design for this study where research method and strategy, inclusion and exclusion criteria along with the research ethics are discussed. At the end, timescale and expected results are presented

 

Introduction

The financial sector plays crucial role in influencing macro-economic growth of any country both directly and indirectly, making them key to realisation of better returns for government securities and instrument. Directly, financial sector take part in distribution and rechanneling of credit. Consequently, highly developed financial systems are likely to promote efficient credit management leading to better asset returns (Boubaker et al., 2017). Secondly, the market conditions and dynamics do differ, and it is possible that these may disturb the financial development and macro-economic dynamics (Dimic et al., 2016). Further, the foreign investors, interested in government bonds tend to have greater confidence in bonds from economies with well developed financial systems, creating greater potential for increased bond return. In light of the foregoing, this study will examine how financial development a cross countries influences the government yield bonds and how such relationship compare in different market economies (namely developed and developing market economies).

Research Questions and Hypothesis Formulation

This study seeks to address the following two research questions:

1. What is the relationship between domestic financial development and the return in sovereign bonds across various economies?
2. How does the relationship between financial development and returns in sovereign bonds compare between various groups of economies (the developed and developing economies)?

The topical arrangement for the substantive part of the literature review will be consistent with the two research questions defined for the study.

The relationship between economic growth and stock returns have been a subject of a number of past studies (Dellas and Hess, 2005; Li et al., 2016), which many studies pointing towards a positive response of stock returns to economic growth.  Developed financial market is likely to create a good market condition for trading the government bonds, in addition to attracting investor confidence, both of which are expected to stimulate investment on the government stock and greater returns.  Consequently, the following hypothesis is formulated:

• Ha1: The financial growth in a country has a positive association with return in sovereign bonds.

Further, developed economies tend to have greater degree of economic stability (Li et al., 2016) and higher investor confidence (Dimic et al., 2016). In light of these preliminary literatures, the direction of the relationship may favour either of the economies. The study, consequently, formulates the following possible alternate hypothesis for the cross- country study:

• H_a2: The effect of financial growth on sovereign bond returns differs between developed that in developing countries.
• H₀2 the effect of financial growth on sovereign bond returns has no significant variation between the developed that in developing countries.

The study will rely on the past studies to address these  suggested hypothesis.

Significance of the Study

The government bonds have always formed a crucial source of government funding.  In the recent past, more countries have resorted to bonds, notably in the Euro area during the recent wave of Euro-crisis. To win investors and international repute, countries need to invest effectively on institutional developments that would help sovereign bonds generate greater returns (Eichler & Plaga, 2016).) . This topic is therefore of vital policy interest, to the extent that it examines the factors of sovereign bond return, in this case financial developments.  Again, by examining on the variation between the relationships across various markets, the study offers further insights on how market conditions (inferred from country development classification) could influence on the government bond yield. Such knowledge provides deeper insights on the influence of environmental factors on the on the bond yield.   The research therefore has both theoretical and policy value. 

Research Methodology

            Research purpose  

The purpose of the study is to critically examine how financial development a cross countries influences the government yield bonds, and the variation of such impacts across different global economies.

            Research Strategy and Method

This study adopts a qualitative research design applying systematic literature review to assess the relationship between  financial markets development  and  sovereign bond yield. These variables will form part of the search terms (key words) for purposes of locating the suitable literature for the proposed literature review topics.  Each of the variables could have more proxies, which will also be used in locating studies on specific aspects of the variables.  Key proxies to financial markets development include:  the private credit to GDP ratio, sovereign credit rating, growth in private credit, global financial condition and global bond market returns (Boubaker et al., 2017; Mohapatra et al., 2017).  In terms of comparing countries at their development levels, this study prefers to categorise the nations into either developed or developing economies. However, some studies have refined the categories, resulting into high- income, medium income and low income economies (Henderson et al., 2013). The study takes cognisance of that , and will  cluster the medium and low income economies into the developing economies’ group to allow easier synthesis with other literature that have used only two-tier classification of country’s economic growth level.

Inclusion and Exclusion Criteria

To ensure that high quality answers are obtained for the research questions, the researcher will   limit selection of article to empirical studies carried out by reputable authors or those published in a peer reviewed academic journals.  Peer-review ensures high quality through an objective blind review by non-partisan experts, ensuring high quality. However, where journal article is not peer reviewed, a background check of the expertise and qualification of the authors will offer a further safeguard, with only works of authors who command authority in the subject being included. Books, commercial websites and media sources will not be included due to their low credibility value.  Another quality safeguard will be time limit for the publication. The study will only sample articles published in the past 20 years (2007-2017) so as to enhance validity. Trading in securities and financial markets are generally dynamic, and therefore factors of bonds that applied five decades ago may not necessarily hold. Such obsolesce in knowledge will be limited through restricting publication timeframe.

Research ethics and method consideration

This study will involved the use of secondary data, which will be cited properly to avoid plagiarism  There are no human  participants , therefore those ethical considerations relevant to human –based research do not apply to high.

Research Implications 

The research on the relationship between sovereign bonds and market developments is a developing one, in need of further synthesis to realist a robust theoretical development and workable model by linking various literatures on the topic.  This study will examine various empirical studies relevant to the research questions, towards this end. 

Timescale

The study will start in the sixth week  to week 24, as indicated below.

            Expected Results

The study expects to that  financial growth in a country has a positive association with return in sovereign bonds. Further, On the other hand, the developing economies have higher prospects of faster economic growth, which may attract rational investors who most likely will be speculating faster economic growth. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

References

Babajide, A. A., Isola, L. A., & Somoye, R. O. (2016). Stock market response to economic growth and interest rate volatility: evidence from Nigeria. Retrieved from http://www.econjournals.com/index.php/ijefi/article/download/1608/pdf

Boubaker, S., Nguyen, D. K., Piljak, V., & Savvides, A. (2017).Financial Development, Government Bond Returns, and Stability: International Evidence. Retrieved from https://www.researchgate.net/profile/Andreas_Savvides/publication/316664021_Financial_Development_Government_Bond_Returns_and_Stability_International_Evidence/links/590ac4a80f7e9b1d0823eda9/Financial-Development-Government-Bond-Returns-and-Stability-International-Evidence.pdf

Dimic, N., Kiviaho, J., Piljak, V., & Äijö, J. (2016).Impact of financial market uncertainty and macroeconomic factors on stock–bond correlation in emerging markets. Research in International Business and Finance, 36, 41-51.

Eichler, S., & Plaga, T. (2016).How Do Sovereign Bond Investors Judge the Economic Performance of the Government? Retrieved from https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2888874

Henderson, D.J., Papageorgiou, C., Parmeter, C.F. ( 2013). Who benefits from financial development? New methods, new evidence.European Economic Review 63, 47–67.

Li, X. L., Balcilar, M., Gupta, R., & Chang, T. (2016). The causal relationship between economic policy uncertainty and stock returns in China and India: evidence from a bootstrap rolling window approach. Emerging Markets Finance and Trade, 52(3), 674-689.

Mohapatra, S., Nose, M., & Ratha, D. (2017). Determinants of the distance between sovereign credit ratings and sub-sovereign bond ratings: Evidence from emerging markets and developing economies. Applied Economics, 1-23.