Sovereign Spreads and Contagion Effect

Abstract

This paper studies the existence of contagion in Chile, using data of the sovereign debt spread for the period 1999-2006. Although we found a strong degree of interdependence between the Chilean series and the rest of the region, we reject the hypothesis of contagion from Brazil to Chile for the period studied. We use a threshold model and find that the effect of EMBI Brazil in EMBI Chile is not constant. When EMBI Brazil is above 800 bp, its effect over EMBI Chile decreases. This indicates that there is no contagion effect. Instead, when Brazil is in a crisis, its effect over Chile is lower than in normal periods. This result gives us evidence to say that countries with strong fundamentals, like Chile, have a lower probability of responding to a negative shock in a neighbor country.