The Risks and Returns of Brady Bonds in a Portfolio Framework

This paper examines the risks and returns of Brady bonds for the period 1990–1995 in a Modern Portfolio Theory framework. We find: (1) that the realized returns of Brady bonds are lower than the realized returns of other asset classes such as US stocks or US bonds; and (2) Brady bonds exhibit higher volatility compared to the other asset classes. These findings are largely explained by the influence of Mexico's devaluation of the Peso in December 1994. In addition, Mexico's devaluation is found to have had a strong (adverse) contagion effect on the returns on Brady bonds of other countries. The paper also finds that Brady bonds exhibit low correlations with US stocks and bonds markets. Thus, we find that there are potentially positive diversification gains from including Brady bonds in a domestic (US investor's) portfolio.