Forecasting local currency bond risk premia of emerging markets: The role of cross-country macrofinancial linkages

In this paper, we forecast local currency debt of five major emerging market countries (Brazil, Indonesia, Mexico, South Africa, and Turkey) over the period January 2010 to January 2019 (with an in-sample period: March 2005 to December 2009). We exploit information from a large set of economic and financial time series to assess the importance not only of "own-country" factors (derived from principal component and partial least squares approaches), but also create "global" predictors by combining the country-specific variables across the five emerging economies. We find that, while information on own-country factors can outperform the historical average model, global factors tend to produce not only greater statistical and economic gains, but also enhance market timing ability of investors, especially when we use the target variable (bond premium) approach under the partial least squares method to extract our factors. Our results have important implications not only for fund managers but also for policymakers.