Fear of disruption: a model of Markov-switching regimes for the Brazilian country risk conditional volatility
AbstractIn the literature, little role is attributed to the country risk conditional volatility in the determination of the macroeconomic equilibrium in a developing small open economy (DSOE). This paper posits the prime hypothesis that, in the presence of multiple equilibria and self-fulfilling prophecies, one of the reasons why investors prefer to speculate in a determined country’s sovereign bonds, raising its country risk levels, is the switch of the expected macroeconomic fundamentals’ conditional variance towards a higher regime. Non-linear GARCH models are applied to monitor different switching regimes of the Brazilian country risk conditional volatility, with special emphasis on Markov switching regimes. Results indicate that the high volatility regime periods, better identified by the latter, coincide with all the severe liquidity crisis episodes suffered by Brazil from May 1994 through September 2002. Thus, although not free of limitations, the country risk’s high conditional volatility regime might determine a bad equilibrium and its monitoring might work as a practical tool to assess the duration of liquidity crises in a DSOE highly dependent on foreign capital inflows such as Brazil.
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Bibliographic InfoPaper provided by EconWPA in its series Econometrics with number 0509005.
Length: 22 pages
Date of creation: 04 Sep 2005
Date of revision:
Note: Type of Document - pdf; pages: 22
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Markov switching; non-linear GARCH; conditional volatility; country risk; multiple equilibria; self-fulfilling prophecies; liquidity crisis.;
Find related papers by JEL classification:
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-11-09 (All new papers)
- NEP-FIN-2005-11-09 (Finance)
- NEP-FMK-2005-11-09 (Financial Markets)
- NEP-IFN-2005-11-09 (International Finance)
- NEP-MAC-2005-11-09 (Macroeconomics)
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