Dissertations, Theses, and Capstone Projects

Date of Degree


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Degree Name





Salih N. Neftci

Committee Members

Michael Grossman

Thom Thurston

Subject Categories



In this thesis we investigated the long-run relationships among risk premiums for long-run government bonds of seventeen countries from four regions (East Europe, East Asia, Africa and Latin America). To do this I applied the cointegration test determining the long-run dynamics among the risk premiums, while also employing a vector error correction model that abstracts simultaneously the short-run and long-run information about the relationships. Causality tests were also performed to determine the influence of each risk premium on others.

The results indicated that there is a strong long-run relationship among the risk premiums for each region. In other words, the risk premiums in each region are cointegrated. At the same time we can apply this cointegration method to test the theory of Market Efficiency in the bonds market for these four different regions. The absence of cointegration (absence of a long-run equilibrium) would suggest that the government bonds market is consistent with the Efficient Market Hypothesis. However, the results suggested that the emerging bond markets in each region I investigate have inefficient and predictable markets (it is possible to forecast the risk premium/risk spread), indicating that the Efficient Market Hypothesis does not hold in these specific markets.

After establishing that the countries, as a group in the government bonds markets were cointegrated, we next employed a Vector Error Correction Model (VECM) to tie the short-run behavior of each series to its long-run values. In general, from the VECM the coefficients that represented the speed-of-adjustment parameters were higher in East Europe than the other three regions of Latin America, Africa and East Asia, and because of this the values adjusted relatively faster to changes in the equilibrium relationship. When we observed the different cointegrating vectors, there appeared to be a fairly regular cyclical component that may be related to the business cycle. Upon comparing the cointegrating vectors in different regions that capture the long-run stationary relationship among the risk premiums, we saw that the East Asian market has less fluctuation compared with the fluctuation in the Eastern Europe and Latin American markets. The Eastern Europe and Latin American markets were more volatile, with the highest fluctuation being in the Latin American market.

By performing a causality test, we found that risk premium shocks were transmitted from large countries, with large economies, to smaller economies. For the overall period of study, Brazil, Mexico and Russia, played an influential role in their regions.

To obtain additional insights into the short-run transmission mechanisms among risk premiums, impulse response functions were computed. The impulse response functions showed that almost always shocks worked through the system very quickly. We also saw that the sharpest and most volatile responses occurred between day zero and day two, and that these responses were positive.


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