Financial Integration of Corporate Bond Markets in India: Empirical Evidences

Abstract

Considering the background of the global debt markets and India‗s competitive position, this research thesis assesses the state of the corporate bond markets in India and attempts to derive specific findings on the nature of its functioning. The macro-economic drivers of Corporate Bond Market along with the factors constraining development of Indian corporate bond markets are also determined. We have also highlighted a few models for the Corporate Bond Market as well as conducted yield estimation of bond portfolios and studied investor sentiments and its impact on integrated markets. This study has made an attempt to identify critical determinants and summarise isssues in the pricing of corporate bonds in India.
There are numerous studies which have identified the influence of macro factors on the capital markets, equity market and other financial markets. However, little attention has been drawn on its influence on the corporate bond market. Investor sentiment is a hugely researched area in behavioural finance but studies related to the impact of investor sentiment on corporate bond market participation are rare in global context and fewer in Indian context. The literature related to ratings led to the conclusion that there had existed few studies related to debt markets in general, but not many such were found to be related for corporate debts in the Indian context. Likewise, there have been a lot of studies on financial integration of equity markets to other domestic market segments or global peer markets, but only limited numbers of studies have focussed on financial integration of the corporate bond market in Indian context. This research study will try to plug holes in existing literature through the following objectives.
1. To study the development of the market of corporate bonds in India with special reference to current status and future challenges.
2. To examine the influence of macro-economic factors and related institutional factors on the corporate bond market in India.
3. To explore the antecedents influencing investor sentiment and to propose and validate a comprehensive empirical model in Indian corporate bond market.
4. To determine the premium of corporate bonds using idiosyncratic and liquidity factors, by presenting a simple, transparent and auditable model.
5. To estimate the yield of corporate bonds with respect to Liquidity conditions as a case for financial market integration.
The study reveals that foreign exchange reserve is important among the selected macroeconomic variables which affects the corporate bond market. Regarding Investor sentiment in the Corporate bond market, the results of this research affirm that market infrastructure, regulatory policy, risk appetite, and policy incentives significantly drive investor sentiment.
This study also dwells upon an important issue of arriving at the liquidity premium of corporate bonds are not easy to compute on account of the issues with liquidity of more than few corporate bonds. This section presents a simple, transparent and auditable model of the term structure of corporate bonds. The classic dynamic Nelson-Siegel method implemented by Diebold and Li (2012) is compared with our approach which is adaptive, parsimonious, simple and scalable. We find ratios of liquidity can explain the spread over 3.67 times more than an investment rating of corporate bonds, as compared to Li et al. (2016) who report the liquidity spread as 1/4th the spread for investment-grade bonds. This approach can enable practitioners to fit a yield curve to observed rates and produce a satisfactory curve. We also assessed the current level of integration using multiple regressions and error correction. The data include daily traded bonds reported in FIMMDA and NSE archives during a fifteen year period from January 1999 to December 2014. We found a significant bond yield with instruments of other markets such as domestic credit markets, money markets, and external credit markets. We also find relatively lower degrees with forex markets and no relationship with any of the commodity or economic indicators.
The study concludes that the bond markets in India continue to face the challenges of genuine and active invetor interests. Although, the importance of a deep and liquid market has been realized the response of participants has not been significant. Numerous policy initiatives to reduce the dominance of bank lending in the economy to the corporates has failed to desisit firms to seek bonds instead of primary debt.