Description

In this paper, we examine the importance of idiosyncratic and common factors in the volatility of sovereign spreads, with a special focus on Chile. After employing the recent procedure developed by Bai and Ng (Econometrica, 2002) to determine the number of common factors in panel analysis, our empirical results support the view that few common factors explained most of the variability of sovereign spreads between january 1998 and june 2004. Moreover, common factors explained larger shares of sovereign spread volatility in non-investment economies, which we consider consistent with a differentiation of international investors based on sovereign ratings. On the other hand, a symmetric two-sample period analysis shows that idiosyncratic factors are becoming more relevant in shaping the variability of sovereign spreads. Finally, our results suggest that the recent downturn in chilean sovereign spread has been associated to a dual decrease of domestic and common factors.