Fear of disruption: a model of Markov-switching regimes for the Brazilian country risk conditional volatility

Maurício Une and Marcelo Savino Portugal
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Marcelo Savino Portugal: PPGE/UFRGS

Econometrics from University Library of Munich, Germany

Abstract: In the literature, little role is attributed to the country risk conditional volatility in the determination of the macroeconomic equilibrium in a developing small open economy (DSOE). This paper posits the prime hypothesis that, in the presence of multiple equilibria and self-fulfilling prophecies, one of the reasons why investors prefer to speculate in a determined country’s sovereign bonds, raising its country risk levels, is the switch of the expected macroeconomic fundamentals’ conditional variance towards a higher regime. Non-linear GARCH models are applied to monitor different switching regimes of the Brazilian country risk conditional volatility, with special emphasis on Markov switching regimes. Results indicate that the high volatility regime periods, better identified by the latter, coincide with all the severe liquidity crisis episodes suffered by Brazil from May 1994 through September 2002. Thus, although not free of limitations, the country risk’s high conditional volatility regime might determine a bad equilibrium and its monitoring might work as a practical tool to assess the duration of liquidity crises in a DSOE highly dependent on foreign capital inflows such as Brazil.

Keywords: Markov switching; non-linear GARCH; conditional volatility; country risk; multiple equilibria; self-fulfilling prophecies; liquidity crisis. (search for similar items in EconPapers)
JEL-codes: C22 E44 F41 G15 (search for similar items in EconPapers)
Pages: 22 pages
Date: 2005-09-04
New Economics Papers: this item is included in nep-fin, nep-fmk, nep-ifn and nep-mac
Note: Type of Document - pdf; pages: 22
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpem:0509005

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