The Dynamics of Credit Spreads on Latin American Eurobonds
28 Pages Posted: 25 Mar 2008 Last revised: 15 Jul 2010
Date Written: July 15, 2010
We investigate two important relationships using the most liquid and option-free, sovereign Eurobond issues of major Latin American economies: the determinants of credit spread changes using variables derived from structural and macroeconomic theory; and the impact of a default episode on the underlying equilibrium dynamics of credit spreads.
We find four significant determinants that drive the credit spreads in these markets: an asset and interest rate factor - consistent with structural models of credit spread pricing; exchange rate factors - consistent with macroeconomic determinants and the slope of the yield curve - consistent with a business cycle effect.
The statistical significance of the exchange rate factor, which also proxies for country risk and the slope variable may be attributed to the sovereign risk premium demanded by investors before buying these bonds. We also find significant autoregressive moving average (ARMA) effects when modelling spread returns indicating a degree of inertia associated with the pricing of sovereign credit spreads in these emerging markets.
Finally, an intra-regional analysis of sovereign yields reveals a shift in the long run equilibrium dynamics around the Argentine default on the 23rd of December 2001. Specifically there was a decline in the importance of the cross border cointegration relationship: intramarket relationships have become more important than intermarket (bivariate or pairwise) relationships.
Keywords: Credit spreads, Latin America, Long-run dynamics, Sovereign bonds, Structural models
JEL Classification: G15
Suggested Citation: Suggested Citation