Essays on asset pricing in emerging markets

The first essay, entitled “A Model of Unexpected Returns in Emerging Markets,” conducts an event study of the abnormal returns that accompany revisions in sovereign creditworthiness. The model incorporates the lessons of the sovereign risk literature in an empirical asset pricing context which assumes that economies are financially integrated in the world. If so, local information should matter only if it affects the exposure to priced sources of world risk or if it implies a revision of expected cash flows. Given their lower unconditional betas, emerging markets tend to have lower unconditional expected returns than developed markets. However, conditional on a run of surprisingly favorable changes in local conditions, expected returns of emerging markets are well above conditional expected returns of developed countries.; Most of the international financing for emerging markets comes under the form of credit as opposed to equity investment. The sovereign credit rating is a key covariate of the cost and availability of such financing. The second essay documents and rationalizes the “Statistical Properties of Sovereign Credit Ratings.” It constructs a rational expectations model of ratings, derives testable hypotheses, and conducts a statistical analysis based of the ratings awarded by Institutional Investor. The model is able to rationalize the key properties of the ratings documented in the paper. These properties are used to forecast future ratings. The implied surprise credit revisions are used in the first chapter to proxy for surprisingly favorable changes in local conditions of investment host countries.; The third chapter, entitled “A Macroeconomic Factor Model Decomposition of Stock Returns: Argentina 1993–1998,” takes a view opposite to that of the first chapter in that if economies are financially isolated, their equilibrium returns should depend on local sources of risk. Four measures of local risk are used and they are gauged at monthly intervals: sovereign risk, yield curve risk, output growth risk and the factor capturing unobservables. The estimated risk premia commanded by most, but not all, of these factors are in accordance with standard micro theory.