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An Analysis of the Impact of External Financial Risks on the Sovereign Risk Premium of Latin American Economies

Listed author(s):
  • Rodrigo Alfaro
  • Carlos Medel
  • Carola Moreno

This article presents a quantification of the response of the sovereign risk premium (EMBI) of a group of Latin American countries, to unexpected changes (shocks) in external financial variables. A vector autoregressions is estimated for each country (Colombia, Chile, Mexico, and Peru) in monthly frequency that includes China's and Brazil's EMBI, the global volatility index (VIX), plus the value of the dollar against a basket of currencies (Broad Index) and a proxy of the slope of the US Treasury yield curve (Spread US). The VIX and Broad Index shocks turn out to have a relatively homogenous effect on each country's EMBI, while shocks to the China and Brazil EMBI are more heterogeneous. For the case of Chile, we further study three alternative risk scenarios, incorporating the copper price as an additional variable. The most disruptive scenario at the time when the shock hits is the Volatility driven one. Nevertheless, it is the Emerging market's scenario (namely one with simultaneous shocks to China’ and Brazil’s EMBI) the one with the most harmful dynamics, as it dyes out slower. Finally, a Copper price bust scenario, in which the price of copper drops significantly in addition to a shock to the EMBI China, is the one with the least effect as the price of copper is relatively less affected by shocks to other variables, displaying lower spillovers.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 795.

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Date of creation: Dec 2016
Handle: RePEc:chb:bcchwp:795
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  1. Joshua Aizenman & Mahir Binici & Michael M. Hutchison, 2016. "The Transmission of Federal Reserve Tapering News to Emerging Financial Markets," International Journal of Central Banking, International Journal of Central Banking, vol. 12(2), pages 317-356, June.
  2. Martín González-Rozada & EduardoLevy Yeyati, 2008. "Global Factors and Emerging Market Spreads," Economic Journal, Royal Economic Society, vol. 118(533), pages 1917-1936, November.
  3. Jun Pan & Kenneth J. Singleton, 2008. "Default and Recovery Implicit in the Term Structure of Sovereign "CDS" Spreads," Journal of Finance, American Finance Association, vol. 63(5), pages 2345-2384, October.
  4. Eichengreen, Barry & Gupta, Poonam, 2015. "Tapering talk: The impact of expectations of reduced Federal Reserve security purchases on emerging markets," Emerging Markets Review, Elsevier, vol. 25(C), pages 1-15.
  5. Kennedy, Mike & Palerm, Angel, 2014. "Emerging market bond spreads: The role of global and domestic factors from 2002 to 2011," Journal of International Money and Finance, Elsevier, vol. 43(C), pages 70-87.
  6. Pesaran, H. Hashem & Shin, Yongcheol, 1998. "Generalized impulse response analysis in linear multivariate models," Economics Letters, Elsevier, vol. 58(1), pages 17-29, January.
  7. Francis A. Longstaff & Jun Pan & Lasse H. Pedersen & Kenneth J. Singleton, 2011. "How Sovereign Is Sovereign Credit Risk?," American Economic Journal: Macroeconomics, American Economic Association, vol. 3(2), pages 75-103, April.
  8. Eyssell, Thomas & Fung, Hung-Gay & Zhang, Gaiyan, 2013. "Determinants and price discovery of China sovereign credit default swaps," China Economic Review, Elsevier, vol. 24(C), pages 1-15.
  9. Iva Petrova & Michael G Papaioannou & Dimitri Bellas, 2010. "Determinants of Emerging Market Sovereign Bond Spreads; Fundamentals vs Financial Stress," IMF Working Papers 10/281, International Monetary Fund.
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