The determinants of default risk in Brazil

Abstract

We formulated a general unrestricted model of the Brazilian Emerging Markets Bond Index Plus (EMBI+) spreads, a proxy for the country's default risk. Employing algorithms that perform automated model selection, we found that macroeconomic fundamentals, such as current account deficit ratio to gross domestic product, public deficit ratio to gross domestic product and imports over foreign exchange reserves, can explain a great part of the variation in EMBI+ spreads. There is also robust evidence of systematic contagion from Argentina and Mexico and that the variance of the spread also affects its mean.

Acknowledgements

I thank, without implicating, Hans-Martin Krolzig and Miguel León-Ledesma for useful comments on an earlier version of this paper. The paper also benefited from comments of participants at seminars at the University of Kent (UK), FGV-SP and Ibmec-SP (Brazil). I also acknowledge financial support from USP, CNPq and Fapesp of Brazil.

Notes

¹ As the empirical results strongly support the correlation between macroeconomic variables and spreads, we will proceed under the assumption that spreads correspond to default risk and throughout the text we will use both denominations as synonyms.