ALL FOR ONE … ONE FOR ALL? A PRINCIPAL COMPONENT ANALYSIS OF LATIN AMERICAN BRADY BOND DEBT FROM 1994 TO 2000

Kevin Paul Scherer () and Marco Avellaneda ()
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Kevin Paul Scherer: Courant Institute of Mathematical Sciences, New York University, 251 Mercer St., New York, NY 10012, USA
Marco Avellaneda: Courant Institute of Mathematical Sciences, New York University, 251 Mercer St., New York, NY 10012, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2002, vol. 05, issue 01, 79-106

Abstract: We use Principal Component Analysis (PCA) to study the Brady Bond Debt of the four primary Latin American sovereign issuers: Argentina, Brazil, Mexico, and Venezuela. Our dataset covers a period of 5½ years starting in July 1994 and consists of daily sovereign ("stripped") yield levels for the par and discount debt securities of each country. We examine the behavior of the characteristic roots and eigenvectors of the empirical covariance matrices computed sequentially over different periods. We show that, by and large, there exist two statistically significant components, or factors, which explain up to 90% of the realized variance. The eigenvector with largest eigenvalue corresponds to the variance attributable to "regional" ("Latin") risk. The second component strongly suggests the existence of a volatility risk factor associated to Venezuelan debt in relation to the rest of the region. A time-dependent factor analyis reveals that the importance of the variance explained by the factor changes over time and that this variation can be interpreted to some extent in terms of market events. In particular, we investigate the relation between the evolution of the PCA factors with the market dislocations that ocurred during the observation period, including the so-called Tequila effect, Asian flu, Ruble devaluation, and Real devaluation.

Keywords: Principal component analysis; brady bond debt; credit confagion (search for similar items in EconPapers)
Date: 2002
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DOI: 10.1142/S0219024902001365

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