Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid -...

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Banco de España Investment Banks’ Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting Director OECD Development Centre

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Page 1: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

Banco de España

Investment Banks’ Recommendations and Emerging Markets: The Usual

Suspects

Madrid - January

2008

Javier Santiso

Chief Economist and Acting Director

OECD Development Centre

Page 2: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

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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

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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.

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ObjectiveObjective11

Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations

22 Capital Flows and Brokers PublicationsCapital Flows and Brokers Publications

33

Overview

Conclusions and Policy LessonsConclusions and Policy Lessons44

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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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Recommendations Database

• 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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Recommendations Database

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Recommendations Database

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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Recommendations Database

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).

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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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Determinants of capital flows

: 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

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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)

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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)

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Determinants of capital flows

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.

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ObjectiveObjective11

Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations

22 Capital Flows and Brokers PublicationsCapital Flows and Brokers Publications

33

Overview

Conclusions and Policy LessonsConclusions and Policy Lessons44

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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).

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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).

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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.

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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

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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)

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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 .

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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)

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Underwriters’ Recommendations

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)

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Underwriters’ Recommendations

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

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Underwriters’ Recommendations

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

Source: The authors based on Dealogic, 2007

Argentina Brazil

Chile Colombia

Mexico

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27

Underwriters’ Recommendations

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

Source: The authors based on Dealogic, 2007

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

Source: The authors based on Dealogic, 2007

Argentina Brazil

Chile Mexico

Venezuela

Page 28: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

28

Underwriters’ Recommendations

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

Source: The authors based on Dealogic, 2007

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

Source: The authors based on Dealogic, 2007

Argentina Brazil

Colombia Mexico

Panama

Page 29: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

29

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

Page 30: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

30

Political and Financial Crisis

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

Page 31: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

31

Political and Financial Crisis

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.

Voter intention for Lula in the opinion polls

(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

Voter intention for Lula in the opinion polls

(left)

bp.Spread Brazil-Emerging Countries and Electoral Polls2002

Source: Datafolha, JP Morgan

Page 32: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

32

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)

Page 33: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

33

Political Events and Bond Recommendations

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

Source:The authors from investment banks' publications, 2007

Simple Average

Weighted Average

Page 34: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

34

Political Events and Bond Recommendations

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

Source:The authors from investment banks' publications, 2007

Presidential election date

Page 35: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

35

Political Events and Bond Recommendations

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

Source:The authors from investment banks' publications, 2007

Presidential election date

Brazil Presidential Election Day 0 = 29 Oct 2006

150

200

250

300

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

Source: Thomson Financial Datastream, The authors, 2007

90

92

94

96

98

100

102

104

Sovereign Bond Spread (lhs.)

Exchange Rate (basis 100=-100)

Second RoundFirst Round

Page 36: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

36

Political Events and Bond Recommendations

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

Source:The authors from investment banks' publications, 2007

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

Source: Thomson Financial Datastream, The authors, 2007

80

85

90

95

100

105

110

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

Second RoundFirst Round

Page 37: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

37

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

Source:The authors from investment banks' publications, 2007

Presidential election dateChile Presidential Election Day 0 = 15 Jan 2006

0

25

50

75

100

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

Source: Thomson Financial Datastream, The authors, 2007

80

85

90

95

100

105

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

Second Round

First Round

Page 38: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

38

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

Source:The authors from investment banks' publications, 2007

Presidential election dateMexico Presidential Election Day 0 = 2 Jul 2000

270

320

370

420

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

Source: Thomson Financial Datastream, The authors, 2007

95

97,5

100

102,5

105

107,5

110

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

Election date

Page 39: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

39

Political Events and Bond Recommendations

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

Source: Thomson Financial Datastream, The authors, 2007

98

100

102

104

106

108

110

Sovereign Bond Spread (lhs.)

Exchange Rate (basis 100=-100)

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

Source:The authors from investment banks' publications, 2007

Presidential election date

Page 40: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

40

Political Events and Bond Recommendations

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

Page 41: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

41

Determinants of the recommendations

• Impact of political events on investment banks’ recommendations :

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

: Pull macroeconomic variables defined by capital markets: Exchange rate, spread of sovereign bonds, equity return, investment value and the weight of the country i in the EMBI Global index (proxy of conflict of interest) .

itMarket

itittititti PoliticalPushaleRMarketc ,Re

tic ,Re

)( ,, tMti rr

Page 42: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

42

Determinants of the recommendations

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

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

: is a dummy variable that takes the value of 1 during presidential elections (3 months before and after the month of the election).

• Period of the analyses: 1997-2007 • Frequency: Monthly.

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

tPush

italRe

itPolitical

Page 43: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

43

Dependent variable: RecommendationsI II III IV V

Exchange Rate (Market ) 0.00000001 0.00000001

(0.67) (0.74)

Spread bp (Market ) -0.0000851*** -0.00008*** -0.00008*** -0.000073*** -0.000079***(-5.61) (-4.98) (-5.09) (-4.85) (-5.21)

Equity (Market ) 0.2176716*** 0.1898*** 0.1913*** 0.17845*** 0.1969***(3.75) (3.67) (4.00) (3.72) (4.06)

Inflation rate (Real ) 0.27420* 0.2630*

(1.74) (1.70)

Industrial Production (Real ) 0.5346*** 0.4995*** 0.4337** 0.43082** 0.41969**(3.12) (2.94) (2.56) (2.53) (2.47)

Var. Interest rate (Real ) 0.0016522 0.00178

(0.38) (0.40)

Var. US interest rate (Push) 0.05544(0.45)

US ind. production (Push) -0.19816(-0.24)

US High Yield (Push) 0.0001593(1.21)

Weight Average (Market) 0.01589*** 0.01567*** 0.01493*** 0.015077*** 0.01522***(5.68) (5.65) (6.01) (6.06) (6.11)

Investment Value (Market) 2.272125*** 2.24*** 2.4249*** 2.4829*** 2.467***(7.29) (7.41) (9.05) (9.30) (9.18)

Presidential Elections ( t-3 , t+3 ) -0.1719525*** -0.1768*** -0.1326***(-3.47) (-3.61) (-2.85)

Presidential Elections before 2006 ( t-3 , t+3 ) -0.12319**(-2.17)

Presidential Elections in 2006 ( t-3 , t+3 ) -0.1236*(-1.67)

Cons -0.08563 -0.0017 0.02417 .0126834 0.0102(-0.98) (-0.05) (0.81) (0.43) (0.35)

N (Observations) 792 792 867 867 867

Adjusted R-squared 0.2059 0.2066 0.2183 0.2152 0.2135

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

Pooled Regression (1997 - 2007)

Determinants of Investment Banks' Recommendations: OLS

Page 44: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

44

Dependent variable: RecommendationsI II III IV V

Exchange Rate (Market ) 0.000286*** 0.00003***(4.51) (4.68)

Spread bp (Market ) -0.000056*** -0.0000552*** -0.000053*** -0.000049*** -0.0000568***(-2.67) (-3.02) (-2.86) (-2.63) (-3.04)

Equity (Market ) 0.17351*** 0.1566194*** 0.200647*** 0.185257*** 0.2050916***(2.99) (3.24) (4.18) (3.85) (4.21)

Inflation rate (Real ) 0.04752(0.27)

Industrial Production (Real ) 0.41874** 0.4614104*** 0.43687*** 0.43474*** 0.42149**(2.45) (2.77) (2.59) (2.57) (2.49)

Var. Interest rate (Real ) 0.002224(0.52)

Var. US interest rate (Push) -0.0231347( -0.19)

US ind. production (Push) 0.475532(0.58)

US High Yield (Push) 0.00014(1.08)

Investment Value (Market) 2.272125*** 2.158372*** 2.3859*** 2.45534*** 2.43761***(7.56 ) (7.93) (8.81) (9.10) (8.96)

Presidential Elections ( t-3 , t+3 ) -0.1719525*** -0.1651272*** -0.148641***(-3.46) (-3.61) (-3.22)

Presidential Elections before 2006 ( t-3 , t+3 ) -0.14745***(-2.62)

Presidential Elections in 2006 ( t-3 , t+3 ) -0.12356*(-1.68)

Cons -0.8528637*** 0.026696 0.1170015*** 0.106045*** .1036628***(-3.93) (0.84) (4.62) (4.28) (4.14)

N (Observations) 792 867 867 867 867

Adjusted R-squared 0.1925 0.1948 0.1741 0.1707 0.1668 t-statistics are in parentheses denoting *** 1%, ** 5% and * 10% significance.

Determinants of Investment Banks' Recommendations: FIXED EFFECTS

Fixed Effects (1997 - 2007)

Page 45: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

45

Determinants of the recommendations

1. The investment value of sovereign bonds and the conflict of interest are significant explanatory variables behind banks’ recommendations.

2. The Political Cycle is a determinant variable in explaining investment banks’ recommendations. More than some standard macro variables.

3. The temporal horizon of investment banks’ recommendations is short term depending more on the continuity of macro policies than on structural reform.

4. The credibility and stability of economic policies has improved in the eyes of Capital Markets analysts. Political risk however still remains an important consideration requiring further efforts on behalf of governments and political parties.

Page 46: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

46

ObjectiveObjective11

Determinants of Banks’ RecommendationsDeterminants of Banks’ Recommendations

22 Capital Flows and Research PublicationsCapital Flows and Research Publications

33

Overview

Conclusions and Policy LessonsConclusions and Policy Lessons44

Page 47: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

47

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.

Page 48: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

48

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?

Page 49: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

49

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.

Page 50: Banco de España Investment Banks Recommendations and Emerging Markets: The Usual Suspects Madrid - January 2008 Javier Santiso Chief Economist and Acting.

50

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 (2008). “Enter the Matrix: Wall Street and Elections in Emerging Democracies”. OECD Development Centre Working Paper, Forthcoming.

http://www.oecd.org/dev