The Usual Suspects

The paper addresses two core questions: do investment banks’ recommendations have an impact on the allocation of portfolio flows in the emerging-markets asset class? Above all, are these recommendations related to the business of investment banks? In order to answer these questions, we constructed a unique database covering the period 1997-2006 for all the bond recommendations made by the major investment banks that dominate the emerging bond markets. The most important findings are as follows: 90 per cent of the underwriters recommend buying or maintaining in their portfolios the bonds issued by the countries where they are acting as lead managers; and investment banks’ recommendations are also correlated with the relative size of the secondary bond market. In fact, there is a phenomenon that we call “too big to underweight” meaning that investment banks do not send negative signals to investors of countries that, given their size, are considered important for their business. Finally, by using panel data analysis, we found that the impact of investment banks’ recommendations on portfolio capital flows is more significant and more predictable than some macroeconomic variables such as interest rate, economic growth and inflation rate. The first of the three major policy lessons at stake is that there is a need for more detailed information disclosure by investment banks in order to determine if past recommendations are related to macroeconomic variables and financial variables or whether they are associated with the investment banks’ business in emerging economies. Second, government agencies should do a strategic monitoring on what market is writing about their respective country vulnerabilities. Finally, given that banks’ recommendations and portfolio flows are related, an international co-operation scheme could be established to encourage investment banks to cover more countries.