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We study the effects of sovereign debt inflows on domestic firms. To do so, we exploit episodes of large sovereign debt inflows, which follow the announcements of the inclusion of six emerging countries into major sovereign debt indexes. We find that these events reduce government bond yields, appreciate the domestic currency, and have heterogeneous stock-market effects on domestic firms. Firms operating in tradable industries experience lower returns than firms in non-tradable industries. In addition, financial firms, government-related firms, and firms that rely more on external financing experience higher returns. The effect on financial and government-related firms is stronger in countries that display larger reductions in government bond yields. The effect on tradable firms is stronger in countries that display stronger appreciations. We provide a stylized model that rationalizes these results. Our findings shed novel light on the channels through which sovereign debt inflows affect firms in emerging countries. ; Pandolfiand Williams acknowledge support from the Einaudi Institute for Economics and Finance (2017 EIEF research grant) and the Columbian College Facilitating Fund from George Washington University. Broner and Martin acknowledge support from the Spanish Ministry of Economy, Industry, and Competitiveness through the I + D Excelencia grant (ECO2016–79823-P), the Spanish Ministry of Science and Innovation through the Severo Ochoa Programme for Centers of Excellence in R&D grant (CEX2019–000915-S), the Generalitat de Catalunya (AGAUR grant 2017-SGR0–1393), the CERCA Programme/Generalitat de Catalunya, and the Barcelona GSE Research Network. Martin also acknowledges support from the European Research Council under EU Seventh Frame-work Programme (FP7/2007–2013) ERC Consolidator Grant (615651-MacroColl).

This paper analyzes the effects on firms of sovereign debt inflows in emerging countries. To deal with the endogeneity between capital inflows and economic activity, we focus on capital inflows driven by countries inclusions into well-known local currency sovereign debt market indexes. These events convey little information about the future economic prospects of countries but induce large capital flows from institutional investors tracking the indexes. We show that inclusion-driven flows significantly reduce government bond yields and appreciate the domestic currency. In turn, these flows have heterogenous impact on firms stock market returns. Government related firms, financial firms and firms with larger financial constraints experience positive abnormal returns following the announcement of these events. Instead, companies operating in export-intensive sectors have negative abnormal returns. Our findings shed novel light on the channels through which capital inflows to sovereign debt markets affect firms in the economy.