The effects of financial risk components on local-currency bond markets: theory and empirical evidence

Based on the ARDL and error correction modelling, we investigate the impacts of financial risk factors on Saudi government bond market over the period 1990–2020. The results indicate that foreign debt stability, debt service stability, and international liquidity stability negatively affected public bond market capitalization (PBMC) in the short run. However, in the long run international liquidity stability does not appear to play a major role in the development of Saudi public bond market, while foreign debt stability constitutes an important factor encouraging government to issue bonds. Moreover, current account and exchange rate stability is positively correlated to PBMC in the long run, highlighting that stable current account and less volatile exchange rates are generally associated with larger local-currency bond markets. Based on these results, the study suggests that multiplying efforts toward new policies in managing financial risk aspects of bonds, mainly those related to international liquidity and debt service, are likely to enhance financial stability, thereby contributing to a greater and deeper domestic bond market.