It is widely believed that local currency bond markets (LCBMs) can promote financial stability in developing countries. For instance, they can help mitigate the currency and maturity mismatch that contributed to the outbreak of the Asian financial crisis of 1997-1998. In this paper, we empirically test such conventional wisdom on the stabilizing effect of LCBMs. To do so, we analyze and compare the financial vulnerability of developing countries during two episodes of financial stress – global financial crisis and taper tantrum. We find that countries which experienced greater expansion of their LCBMs between the two episodes experienced a greater reduction of exchange rate depreciation, indicating a stabilizing role of LCBMs. Our evidence indicates that a gradual expansion of bank loans may also contribute to financial stability. On the other hand, we do not find any evidence of a stabilizing effect of stock market development.
