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

Produced by: 
Banco Central de Chile
Available from: 
December 2016
Paper author(s): 
Rodrigo Alfaro
Carlos Medel
Carola Moreno
Topic: 
Financial Economics
Year: 
2017

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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