The Relationship between Interstate Disputes and Government Bondholders

• In Event: Conflict Processes and Finance

Abstract

How differently do domestic and foreign investors respond to international political risk? Given the fact that foreign investors have increased their presence in government bond markets over the last two decades, factoring in different types of investors provides a more detailed picture of the (ir)rationality of heterogeneous investors in terms of assessing international political risk. Specifically, employing the occurrence of interstate disputes as a proxy for international political risk, this paper investigates to what extent and in which ways market reactions to states’ conflict signals vary by the composition of the investor base for government bonds. Using datasets of Militarized Interstate Disputes and Sovereign Investor Base of 10 developed and 12 developing countries for 2000—2010, my analyses report that the distinctions between foreign and domestic bondholders play out in such a way that foreign investors perceive that the risk the disputes are expected to pose to their bondholding is higher, thereby selling off their government bonds more swiftly than domestic counterparts do. As a result, as a state has a larger share of foreign investors holding its government bonds, government bond yields increase more drastically when the state gets involved in interstate disputes.

Author

• Kyu Young Lee, Saint Lawrence University