banking primer and emerging markets

8/6/2019 Banking Primer and Emerging Markets

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The Usual Suspects:A Primer on Investment Banks

Recommendations and Emerging Markets

Javier Santiso

Chief Economist and DeputyDirector

OECD Development Centre

ConferenceOpening and Innovation on Financial Emerging

MarketsBeijing - China March 28 2007

Sebastin Nieto Parra

Chaire Finances Internationales

Sciences Po Paris

tp://www.financesinternationales.sciences-po.fr/
http://www.financesinternationales.sciences-po.fr/http://www.financesinternationales.sciences-po.fr/


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Objective of the paperI

Overview of the literatureII

Description of the dataIII

Investments banks business and research publicationsIV

Emerging markets capital flows and research publicationsV

ConclusionsVI


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Two core questions

Do recommendations given by investment banks havean impact on the allocation of portfolio flows in theemerging markets?

That reveals the influence of analysts

recommendations on investors behaviour. Above all, do recommendations are related with the

business of investment banks?

Information provided by banks to investors could be

biased depending on their own objective thatsometimes could differ from those of investors.


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ConclusionsVI


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Investment banks recommendations

The impact of investments banks recommendations on capital

markets has been concentrated in OECD countries.- Womack (1996), Jackson (2005), Boni and Womack (2002), Barber et al

(2001), Asquith et al (2005),

Variety of results:

- analysts are confronted by a trade-off between sending true signals and

optimistic signals.- Larger number of buy recommendations than sell recommendations.

- Market reaction to upgrades is less pronounced than the market reaction todowngrades by analysts.

- Impact of the measures introduced by the NYSE and NASDAQ, but also the

sanctions established by the SEC in 2002.


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Research literature on emerging markets is scarce and

concentrated in the equity market:- Seasholes (2000), Bae et al (2005): Accuracy of local vs foreign

forecast analysis.

- Bacmann and Bollinger (2001): Boom of the stocks covered byanalysts between 1993 and 2000.

Empirical studies of the relationship between therecommendations and underwriters are scarce andconcentrated to OECD countries:

- Womack and Michaely (1999). Results suggest that there is a conflictof interest between investment banking and research department.


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Capital Flows to Emerging Countries

A large body has studied the determinants of capital flows:

- Push factors or global factors literature: First half of the 90s Fernandez-Arias (1996) andCalvo et al (1993)

- Pull and Push factors : Taylor and Sarno (1997), World Bank (2001), Alfaro et al (2005),

Most of the results conclude that local factors combined with external factors explain capitalflows (FDI, foreign banks lending, bond and equity flows,).

- In addition to pull and push factors, recent empirical literature has studied the impact ofinformation and distance on capital flows:

Ghosh and Wolf (1999), Savastano (2000), Papaioannou (2004) and Portes and Rey (2005).

In particular Portes and Rey (2005) develop an empirical model in which internationalinformation flows are a significant aspect to explain international equity flows.


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Our research

By using untapped and rich dataset, the purpose of this study:

First, it is an attempt to analyse the determinants of the recommendations given by investmentbanks in the sovereign emerging bond market.

Second, it allows to determine the impact of information on capital flows. For that we take into

account investment banks recommendations as an additional factor to explain capital flows.


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ConclusionsVI


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We have taken the recommendations given by 10

investment banks. All of them important players in theemerging bond markets.

Instit

ABN AMRO


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Main aspects concerning the recommendations given by investment banks:

- Composed only by sovereign emerging debt.

- We have classified three types of recommendations: Overweight (1), neutral (0) andunderweight (-1).

- These recommendations are assimilated to the cases of buying, maintaining andselling with respect to a portfolio (the index EMBI+ calculated by JP Morgan)

Given portfolio restrictions a buying recommendation must be compensated by aselling advice.


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Example: Average of the recommendations given to

Brazil by the investment banks with respect to theweight of Brazil in the EMBI Global index.

Brazil: recom me ndations

(1:overwe ight, 0:neu tral, -1:underw ei

-1

-0.5

0

0.5

1

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

So urce:The authors based on banks publications ,

AVERAGE

To tal Average:0.3

Variance: 0 .29

EMBI Global

(Index weigh t, %

10

15

20

25

30

J un-97 J un-99 J un-01 J un-03 J un-05

Source: J P M organ, april 200

Brazil


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We have taken 11 Latin American countries that

represent nearly 95% of the GDP of the region. Thetotal number of recommendations is over 3,000.

Argentina

INVESTM


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ConclusionsVI


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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 reputationby 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 torecommend optimistically the assets which they are participating asunderwriters in an IPO.


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Underwriters recommendations Recommendations given by banks that have been

underwriters for Latin American sovereign bond issues.

- 90% of the underwriters recommend to investors at theannouncement date of the issue to buy or to maintain in theirportfolio the bonds issued by the countries where they areacting as underwriters.

Underwriters'

Jan. 1999 - Jul


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Size of the market and recommendationsObjective of the sell side business: to sell portfolios to a large variety of

financial intermediaries. The percentage invested in these portfoliosincreases relative to the size of each country.

High correlation between recommendations and size of the market: toobig to underweight

Credit risk is not a relevant variable to determine the recommendations

Argentina


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ConclusionsVI


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Determinants of capital flows

In order to test the impact of recommendations on capital flows (Bond flowsand Equity flows respectively), we have used the following two panel data

regressions models:

(i)

(ii)

where and : percentage allocated by funds in country i with respect to

the total amount invested in emerging economies.

: the average of theinvestment banks recommendations given to country i .

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

ittitititit PushalMarketcBond +++++= ReRe

ittitititit PushalMarketcEquity +++++= ReRe

itBond itEquity

itcRe

itMarket


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: Pull variables that are strongly influenced by real sector (economic activity,

inflation rate and interest rate).

: country invariant variables which capture global factors (US nominal ratesand 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

OLS and FE estimation. Since OLS estimation are known to deal inadequatelywith time series and cross-section heterogeneity, we reported also Fixed

Effects estimates (FEM estimators).

tPush

italRe


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

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

We present only the results of FE estimators with lagged explanatory variables (seeannex for the others results)


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Determinants of bond flows

Dependent vari

Impact of R


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Determinants of equity flows

Dependent varia

Impact of R


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ConclusionsVI


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3 conclusions concerning the determinants of capital flows:

1. The impact of investment banks recommendations oncapital flows is positive and significant.

2. The impact of the recommendations given to external publicdebt goes beyond sovereign bond flows. Indeed, althoughtheir influence is minor, these recommendations also affectprivate equity flows.

3. This new microeconomic variable improves the fit of capitalflows regressions more than some traditional

macroeconomic variables such as interest rates, economicgrowth and inflation rate.


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Business and Investment banksrecommendations

We can not reject the hypothesis that the information transmitted to

investors could be biased with the purpose to obtain short term profitsand to recommend optimistically the assets which banks are

underwriters in an IPO.

Further research:

The results are preliminary. We have in part neglected the role of therecommendations in the sell side long term business.

Indeed, further research must be done concerning the performance ofthese recommendations in terms of investment value and tocontrast them with the underwriting activity.


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Policy Lessons

1. There is a need for more detailed informationdisclosure by investment banks in order todetermine if past recommendations are related tomacroeconomic variables and financial variablesor whether they are associated with their

business in emerging economies.

2. Given that banks recommendations and portfolioflows are related, an international co-operationmust be established in order to encourage

investment banks to cover more countries.


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ANNEXES


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An example of the weight of some Latin American

countries in the EMBI index (depends on the amountoutstanding of sovereign debt).

EMBI Global Marke t W eight (%)

10

15

20

25

30

jun-97 jun-98 jun-99 jun-00 jun-01 jun-02 jun-03 jun-04 jun-05

Source: J P M organ, 2006

0

2.5

5

7.5

10

Brazil

Mexico

Venezuela (rhs.)


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Underwriters recommendations

415 underwriters or Lead managers and 215 sovereign

issues. Almost 75% of the underwriters are located inBrazil, Argentina, Colombia and Mexico.

1

U d it d ti


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Underwriters recommendations:Argentinean case

The Argentinean case is very useful, interesting and special case

- 67 per cent of the recommendations were to maintain the positions in Argentinean

External Debt (prior 2001)

- Some of the comments given by banks months before the crisis were unrealistic:

Morgan Stanley: We are maintaining our Market Perform recommendation on Argentinebonds.Relaxation of fiscal targets and an innovative IMF-led financial package from creditors bothimprove Argentinas credit outlook. Argentina needs to raise an estimated $2.6 billion to fulfil its firstquarter financing requirements. New issues are expected to total $5.6 billion in 2001. Growth andfiscal performance are becoming the focus of investors attention. January 26, 2001.

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

U d it d ti


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Underwriters recommendations:Argentinean case

Source: Nieto Parra (2006) from Bloomberg

0

0.5

1

1.5

2

2.5

3

3.5

0 100 200 300 400 500 600 700 800

Turkey July 2000

Turkey August 1999

Hungary 99 Turkey 2000

Argentina 1999

Argentina 2000

Argentina 2000

FEE

SPREAD

Argentina 2000

Jamaica 2000Colombia 2000Colombia 2001

Argentina 1999Philippine 1999Tunisia 2000

Philippines 2006

Emerging Markets: fee vs spread primary market (1999-2006)


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Underwriters recommendations vs. Recommendations given by other investment banks

- 75% of the Lead mangers advice was higher than or equal to that made by other investment banks.

Underwriters'

Other invest


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Underwriters recommendations vs.Recommendations given by other investment

banks during the announcement date of the issueof a bond.

- On average underwriters recommendations are morefavourable than no-underwriters recommendationsUnderwriters 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.

Brazil

Chile

C

olombia

Dom.Rep.

E

cuador

Mexico

Panama

Peru

Uruguay

Venez.

To

t.Aver.

Weigth.Aver.

Source: The authors, 2006

Underwriter

No underwriter


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What is the incentive that no-underwriters could have to give an equal or higherrecommendation than underwriters?

For most of the Latin American countries 90% of the issues were realised by 10investment banks

# Issu

Part


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Underwriters recommendations By calculating the HHI we obtained the same results:

Theoretically, this market could be characterised by an imperfect competitive market inwhich underwriters are playing a repeated game.

By taking investment banks recommendations as a marketing product, it is thenadvantageous to investment banks to recommend a country even if at that periodthey have not been underwriters.

1999

Argentina 0.14Brazil 0.18Chile 0.50Colombia 0.28Dom. Rep.

Ecuador

Concentration (Herfinda


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.

Dependent varia

Impact


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.

Dependent varia

Impact o


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.

Impact of Re

Dependent varia


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.

Dependent varia

Impact


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.

Dependent varia

Impact o


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Dependent vari

Impact of R

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