Arora, V., and M. Cerisola, 2000, “How Does U.S. Monetary Policy Influence Economic Conditions in Emerging Markets,” IMF Working Paper No. 00/48, (Washington: International Monetary Fund).
Forbes, K., and R. Rigobon, 1999, “No Contagion, only Interdependence: Measuring Stock Market Co-Movements,” NBER Working Paper 7267 (Cambridge, Massachusetts: National Bureau of Economic Research).
Garcia Herrero, A., and A. Ortiz, 2005, “The Role of Global Risk Aversion in Explaining Latin American Sovereign Spreads,” Documento de Trabajo No. 0505 (Madrid: Banco de España).
Gelos, R. G. and R. Sahay, 2001, “Financial Market Spillovers in Transition Economies,” Economics of Transition, Vol. 9 (January) 2001, pp. 53–86.
González Rozada, M., and E. Levy Yeyati, 2005, “Global Factors and Emerging Market Spreads” Documento de Trabajo 07/2005 (Buenos Aires: Universidad Torcuato Di Tella).
Jaque S., and A. Rojas O., 2003, “Determinants of the Chilean sovereign Spread: Is it Purely Fundamentals?” Money Affairs, Vol. XVI, N.2., July–December 2003, CEMLA.
Kamin, S., and Karsten von Kleist, 1999, “The Evolution and Determinants of Emerging Market Credit Spreads in the 1990s,” Federal Reserve Board of Governors, International Finance Discussion Papers No.653.
Kanagasabapathy, K., and Rajan Goyal, 2002, “Yield Spread as a Leading Indicator of Real Economic Activity: an Empirical Exercise on the Indian Economy,” IMF Working Paper 02/91 (Washington: International Monetary Fund).
Larzabal, M., M. Valdes, and S. Laporta, 2001, “Spread Soberano: Evidencia Empírica del Caso Uruguayo,” Departamento de Estudios de República AFAP S.A.
Mauro, P., S. Nathan, and Y. Yishay, 2000, “Emerging Market Spreads: Then Versus Now,” IMF Working Paper 00/190 (Washington: International Monetary Fund).
Min, H., 1998, “Determinants of Emerging Market Bond Spread: Do Economic Fundamentals Matter?” Policy Research Working Paper No. 1899 (Washington: World Bank).
In the remainder of the paper, credit ratings refer to foreign currency long-term debt.
Financial market volatility is proxied by the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options, which aggregates market expectations of volatility over the next 30-day period. To measure the average spread of U.S. speculative grade corporate bonds (a proxy for investor risk appetite) the Merry Lynch high yield index is used.
Following Forbes and Rigobon (1999) and Gelos and Sahay (2001), a formal test of increase in correlation, applying the correction for changes in variance, was conducted, confirming the findings. As the variance has fallen in the post crisis period, the adjustment accentuates the increase in correlations.
It is also interesting to note the impact of Uruguayan shocks on Chilean spreads (at 10 percent significance level) in the pre-crisis period, and the following reversion in the direction of causality after the crisis.
Since the table displays pairwise tests, results should be interpreted with caution. Spillover from small countries in the region is likely to reflect aggregate shocks to either all emerging markets or to the region.
Increased correlation and financial spillovers from non-investment grade countries may reflect a change in the set of investors for Uruguayan debt instruments, due to the fact that some institutional investors (often with buy-and-hold strategies) are not allowed to hold instruments with speculative ratings.
In June 2007, S&P introduced a new methodology for rating sovereign debt issuers according to the expected recovery rate in the event of a default. Interestingly, Uruguay's recovery rating (2='substantial recovery') is higher than all graded countries in the region. A higher recovery rating combined with a lower overall rating—vis-à-vis neighboring countries—suggests that, despite a good reputation for debt repayment, Uruguay is perceived to be vulnerable to external shocks.
For most recent work in this topic see Garcia Herrero and Ortiz (2005), Gonzalez Rozada and Levy Yeyati (2005), Jaque et al (2005), Makin and Karsten von Kleist (1999), Mauro et. al (2000), and Min (1998).
The UBI is built from spreads of fixed-rate, dollar-denominated Euronotes and Global Bonds issued by the Uruguayan government. UBI spreads are highly correlated with the Uruguayan EMBI spread produced by JP Morgan, since the introduction of the later in 1998.
Both Trace and Maximum Eigenvalue tests confirm the existence of a unique co-integrating relation.
External debt is excluded as it is highly collinear with the public debt-to-GDP ratio.
Unlike previous work that has stressed the effect of US interest rates on EMC spreads, this link is not found for Uruguay.
These results are consistent with previous work by Larzabal, Valdes and Laporta (2001) covering the pre-crisis period who find that changes in the EMBI had a negative impact on Uruguayan spreads.