## _wp10281 - 1. Description of the Variables

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### Introduction: motivation and high-level findings
- During the current global financial and economic crisis, sovereign bond spreads for both developed and emerging market economies widened dramatically.
- The deterioration has been attributed to large public interventions in support of domestic financial systems and fiscal stimulus packages, which led to rapidly growing public debt and balance sheet risks.
- Countries with large debt stocks and unsound banking sectors were affected the most.
- This paper investigates short- and long-run effects of fundamental (macroeconomic) and temporary (financial market) factors on sovereign bond spreads.
- Key empirical findings:
  - Financial sector vulnerabilities, measured by the Emerging Markets Financial Stress Index (Balakrishnan et. al (2009), IMF (2009c)), appear to be a crucial factor in explaining movements in spreads in the short run.
  - Global liquidity conditions—measured by the volatility index VIX and two U.S. government securities’ yields—have a large impact on short-term sovereign bond spreads.
  - In the long run, macroeconomic factors that affect liquidity and sustainability and political risk are significant determinants of emerging market sovereign bond spreads.
  - Early in the crisis, a surge in global risk aversion was a significant factor influencing sovereign spreads; later, country-specific factors became more important.

### Methodological framework: model structure and theoretical implications
- Model context:
  - A small open economy smoothes consumption via foreign borrowing; foreign lenders focus on the economy’s ability to generate foreign exchange and domestic resources to service external obligations.
  - Framework extends Ferrucci (2003) by incorporating a financial stress index I_t to capture temporary financial distress effects on default probability.
- Key equations and relations (preserved from source):
  - Pricing parity relation: 1+ r = (1+ i_t)(1 – p I_t) + 0 p I_t
  - Spread expression derived in the text: (equation (2) as given in the source)
  - Steady-state relation: ((1– p)^2 i – p)D = T – G and (D/(T–G)) p p r ??? (presentation preserved as equation (3) in source)
  - Relation between p and s: p = (r s)/(s + r + 1) (equation (4) in source)
- Model assumptions and implications:
  - The financial stress index I_t takes values greater than 0 such that 0 < 1 – p I_t in the short run and 1 in the long run.
  - Markets close access to financing for two periods if a sovereign defaults.
  - Government budget constraint incorporates probability-weighted access to markets depending on default history.
  - Long-run theoretical signs implied by the steady-state solution:
    - If (T−G)/Y increases, p and s should decrease.
    - A higher debt to GDP ratio is associated with a higher probability of default and wider sovereign bond spreads.
    - If the stock of debt is greater than the fiscal deficit, an increase in the risk-free interest rate r should lead to a higher probability of sovereign default and larger sovereign bond spreads; hence r and sovereign spreads are positively correlated.
  - In the short run, higher values of the financial stress index imply a wider spread.

### Variable selection and data: variables used and data scope
- Variables used to explain spread levels (verbatim list from source):
  - External debt/GDP
  - Interest payments on external debt/reserves
  - Short-term debt/reserves
  - External debt amortization/reserves
  - Fiscal balance/GDP
  - Current account balance/GDP
  - Trade openness
  - Financial fragility (financial stress index)
  - Risk-free rate and external liquidity conditions (U.S. 3-month Treasury bill rate and 10-year government bond yield, and volatility index VIX).
  - Political risk
- Macroeconomic variable rationale:
  - Fundamentals include r, D, Y, and (T–G).
  - Liquidity indicators are ratios to reserves: external debt amortization, interest payments, and short-term debt; these, with fiscal balance and current account, characterize gross financing needs and are expected to have a positive impact on spreads.
  - External solvency indicators: current account and trade openness (exports + imports to GDP) expected to have negative signs.
- Financial fragility and crisis-period measurement:
  - Emerging Markets Financial Stress Index components:
    - Exchange market pressure index (increases as exchange rate depreciates or reserves decline)
    - Default risk measures (sovereign bond spreads) — index is modified by excluding its sovereign bond spread component to avoid endogeneity
    - Banking sector beta (12-month rolling window)
    - Stock price returns (calibrated so falling prices = increased stress)
    - Time-varying stock return volatility
  - Political instability is included as a variable expected to widen sovereign bond spreads.
- Data coverage:
  - The data set covers 14 countries between the first quarter of 1997 and the second quarter of 2009.

### Data and variable construction
- Dependent variable:
  - Secondary market spreads from JPMorgan’s Emerging Markets Bond Index (EMBI); spread measured as the premium paid by an emerging market over a U.S. government bond with comparable maturity features; country spread index = market-capitalization-weighted average of included instruments (continuous time series).
- Right-hand-side variables:
  - Country-specific macroeconomic fundamentals, external liquidity indicators, political risk and financial stress indices.
- Data sources:
  - IMF International Financial Statistics database
  - IMF Global Data Source
  - Haver Statistics database
  - World Bank database
  - Bloomberg (JPMorgan EMBIG Index)
  - The Economist Intelligence Unit (political risk)
  - Balakrishnan and others (financial stress index)
  - CBOE (VIX)
  - Federal Reserve (U.S. rates)
- Key variables and measurement units (excerpt from Table 1):
  - Spreads: Basis Points, Quarterly, Bloomberg (JPMorgan EMBIG Index)
  - GDP: Dollars, Quarterly
  - External debt: Dollars, Annual (interpolated)
  - Public debt: Percent (stock of public debt to GDP), Annual (interpolated)
  - Short-term debt: Dollars, Annual (interpolated)
  - Interest (payments on external debt): Dollars, Annual (interpolated)
  - Reserves: Dollars, Quarterly
  - Amortization (principal repayments on external debt): Dollars, Quarterly
  - Fiscal balance: Percent (fiscal balance to GDP), Quarterly
  - Current account: Dollars, Quarterly
  - Political risk index: Index (0–100), Quarterly
  - Financial stress index: None, Quarterly
  - VIX: Index, Quarterly
  - U.S. 3-month Treasury bill rate: Percent, Quarterly
  - U.S. 10-year government bond rate: Percent, Quarterly

### Summary statistics and correlations (selected)
- Summary statistics (Table 2 highlights):
  - EMBI Spread observations: 988
  - VIX mean: 21.497 (988 observations)
  - U.S. 3-month Treasury bill rate mean: 0.039 (1,404 observations)
  - U.S. 10-year government bond yield mean: 0.057 (1,404 observations)
- Pairwise correlations (Table 2 / Figure 1 findings):
  - EMBI spreads are highly positively correlated with external debt (External debt/GDP) and public debt (Public debt/GDP).
  - Interest payments/reserves, short-term debt/reserves, and amortization/reserves are positively correlated with EMBI spreads.
  - Political risk index and financial stress index are positively correlated with EMBI spreads.
  - Fiscal balance and current account are not highly correlated with spreads.
  - High positive correlation between ratios of external and public debt: 0.8.
  - Liquidity measures (short-term debt, interest payments, amortization to reserves) are highly correlated among themselves.

### Calibration and model specification
- Econometric approach:
  - Use of pooled mean group (PMG) estimator of Pesaran and Smith (1995) and Pesaran, Shin, and Smith (1999) to capture quarterly frequency panel data.
  - PMG distinguishes short-term from long-term parameters, allows short-term parameters to vary across countries while keeping long-term elasticities constant.
  - Advantages noted: controls for cointegration, imposes commonality on long-run coefficients, allows short-run country specificity.
- Models estimated:
  - Basic log fixed-effects model: sum_j x_jit + alpha_i + epsilon_it form (equation (6) representation).
  - Dynamic error-correction representation incorporating lagged dependent variables and long-run commonality (equation (7)) estimated via PMG.

### Fixed-Effects estimation (key findings)
- Benchmark specification (specification 2) includes all variables; reported explanatory power: R^2 = 0.824.
- Significant coefficients and signs (benchmark/specifications summary):
  - External debt/GDP coefficient ≈ 2.811*** (specification 2); other reported values: 2.856***, 2.811***, 2.626***, 2.813***, 2.915***, 2.809***, 2.795***.
  - Interest payments/reserves examples: 2.055*** (std. err. (0.268)) and variants.
  - Amortization/reserves often negative and significant: -0.499***, -0.599***, -0.597***, -0.604***.
  - Political risk index positive and significant: 0.0185*** (specification 2).
  - Openness negative and significant: -0.737*** (specification 2).
  - Financial stress index positive and significant: 0.047*** (specification 2).
  - VIX positive and significant: 0.0372*** (specification 2).
- Global U.S. rate effects (specification sensitivity):
  - A 1 percentage point increase in the 3-month Treasury bill rate increases EMBI spreads by about 7.463*** percentage points (reported in specification 5).
  - A 1 percentage point increase in the term spread between the 10-year U.S. government bond and the 3-month Treasury bill increases spreads by 7.121** (specification 5).
- Interpretation:
  - Sum of liquidity indicators positive → greater financing needs relative to liquid resources increase sovereign bond spreads.
  - Fiscal balance not consistently significant across specifications.
  - Textual estimate: an increase in debt-to-GDP by 1 percentage point increases spreads by about 2.8 basis points.
  - Financial stress index adds explanatory power: exclusion reduces R^2 by 5 percentage points.

### Pooled Mean Group (PMG) estimation (key findings)
- Long-run vs short-run:
  - PMG results indicate important long-run relationships for fundamentals; short-run dynamics differ across countries.
  - Error correction coefficient (phi) in benchmark equation (2): -0.532*** (std. err. (0.094)); average error correction coefficient reported as -0.53, implying about 50 percent of adjustment to steady state each quarter and about 95 percent dissipation of a shock within a year.
- Selected long-term coefficients (specification 2 and variants):
  - External debt/GDP long-term examples: 2.205*** (specification 2), other values include 2.655***, 5.779***, 1.404***, 2.537***, 2.238***, 2.088***.
  - Interest payments/reserves long-term: 6.754*** (specification 2) and 6.497*** in variants.
  - Amortization/reserves long-term: -1.520*** (specification 2).
  - Fiscal balance/GDP long-term: 3.258*** (specification 2).
  - Current account/GDP long-term: -3.278*** (specification 2).
  - Political risk index long-term: 0.018*** (specification 2).
  - Openness long-term: -0.396 (specification 2) and -4.879*** in specification 3.
  - VIX long-term: 0.026*** (specification 2).
  - U.S. 3-month Treasury bill rate and term spread show large positive long-term coefficients in specifications where domestic liquidity variables are used one at a time (examples: 13.97***, 12.14***).
- Short-term coefficients (selected):
  - Financial stress index short-run: 0.011* to 0.014*** across specifications.
  - VIX short-run: 0.020*** (specification 2).
  - Political risk index short-term: e.g., -0.009** in one specification.
  - Openness short-term: 1.627***, 1.700*** in some specifications.
- Interpretation:
  - Fundamentals (debt ratios, liquidity indicators, political risk, trade openness) determine steady-state (long-run) sovereign spread levels.
  - Financial stress and global volatility (VIX) have important short-run effects; financial stress is largely transitory with rapid dissipation implied by phi.
  - PMG estimates support a strong long-term role for macroeconomic fundamentals, while short-run variation is substantially affected by country-specific financial fragility.

### Discussion of results and policy implications
- Main empirical regularities:
  - Strong long-term relationship between emerging market sovereign spreads and macro fundamentals: debt and debt-related variables, trade openness, liquidity conditions, political risk.
  - Short-run variation in sovereign spreads is more strongly influenced by financial fragility (financial stress index) and global volatility (VIX).
- Policy-relevant implications:
  - Managing debt levels and debt-related flows matters for long-term sovereign borrowing costs.
  - Maintaining adequate reserves and managing short-term external liabilities can reduce liquidity-driven spreads.
  - Political risk mitigation (stability, governance) contributes to lower long-run spreads.
  - Country-specific financial stability policies can mitigate short-run spikes in spreads, given the transitory but strong short-term effect of financial stress.
  - Global monetary and yield-curve conditions (U.S. short-term rates and term spread) can materially affect emerging market spreads, particularly when domestic liquidity cushions are weak.

### Concluding remarks
- Methodological contribution: combined use of fixed-effects and PMG estimation allows distinction between short- and long-term determinants while accommodating country-specific short-run dynamics.
- Empirical conclusions:
  - Short run: financial fragility and liquidity conditions (including global volatility) are major determinants of sovereign spreads.
  - Long run: macroeconomic fundamentals (debt dynamics, current account, openness) and political risk are significant determinants of sovereign spreads.
- Consistency with literature: findings align with Ferrucci (2003) and extend Mody (2009) by highlighting the short-run importance of financial stress beyond simple crisis dummy variables.

*Source: Authors.*

### 1. Description of the Variables ........................................................................................

### _wp10281 - 1. Description of the Variables

### Introduction: motivation and high-level findings
- During the current global financial and economic crisis, sovereign bond spreads for both developed and emerging market economies widened dramatically.
- The deterioration has been attributed to large public interventions in support of domestic financial systems and fiscal stimulus packages, which led to rapidly growing public debt and balance sheet risks.
- Countries with large debt stocks and unsound banking sectors were affected the most.
- This paper investigates short- and long-run effects of fundamental (macroeconomic) and temporary (financial market) factors on sovereign bond spreads.
- Key empirical findings described in the text:
  - Financial sector vulnerabilities, measured by the Emerging Markets Financial Stress Index (Balakrishnan et. al (2009), IMF (2009c)), appear to be a crucial factor in explaining movements in spreads in the short run.
  - Global liquidity conditions—measured by the volatility index VIX and two U.S. government securities’ yields—have a large impact on short-term sovereign bond spreads.
  - In the long run, macroeconomic factors that affect liquidity and sustainability and political risk are significant determinants of emerging market sovereign bond spreads.
  - Early in the crisis, a surge in global risk aversion was a significant factor influencing sovereign spreads; later, country-specific factors became more important.

### Methodological framework: model structure and theoretical implications
- Model context:
  - A small open economy smoothes consumption via foreign borrowing; foreign lenders focus on the economy’s ability to generate foreign exchange and domestic resources to service external obligations.
  - Framework extends Ferrucci (2003) by incorporating a financial stress index I_t to capture temporary financial distress effects on default probability.
- Key equations and relations (preserved as in source):
  - Pricing parity relation: 1+ r = (1+ i_t)(1 – p I_t) + 0 p I_t  (equation labeling and notation preserved)
  - Spread expression derived in the text: (equation (2) as given in the source)
  - Steady-state relation: ((1– p)^2 i – p)D = T – G and (D/(T–G)) p p r ??? (presentation preserved as equation (3) in source)
  - Relation between p and s: (r s)/(s + r + 1) = p  (source gives p as function of s in equation (4): p = (rs)/(s + r + 1))
- Model assumptions and implications:
  - The financial stress index I_t takes values greater than 0 such that 0 < 1 – p I_t in the short run and 1 in the long run, allowing extraneous financial conditions to amplify or ameliorate default probability short term.
  - Markets close access to financing for two periods if a sovereign defaults.
  - Government budget constraint incorporates probability-weighted access to markets depending on default history.
  - Long-run theoretical signs implied by the steady-state solution:
    - If the ratio of fiscal balance to domestic output, (T−G)/Y, increases, p and s should decrease.
    - A higher debt to GDP ratio is associated with a higher probability of default and wider sovereign bond spreads.
    - If the stock of debt is greater than the fiscal deficit, an increase in the risk-free interest rate (r) should lead to a higher probability of sovereign default and larger sovereign bond spreads; hence r and sovereign spreads are positively correlated.
  - In the short run, higher values of the financial stress index imply a wider spread.

### Variable selection and data: variables used and data scope
- Variables used to explain spread levels (verbatim list from source):
  - External debt/GDP
  - Interest payments on external debt/reserves
  - Short-term debt/reserves
  - External debt amortization/reserves
  - Fiscal balance/GDP
  - Current account balance/GDP
  - Trade openness
  - Financial fragility (financial stress index)
  - Risk-free rate and external liquidity conditions (U.S. 3-month Treasury bill rate and 10-year government bond yield, and volatility index VIX).
  - Political risk
- Macroeconomic variable rationale:
  - Fundamentals include r, D, Y, and (T–G).
  - Liquidity indicators are ratios to reserves: external debt amortization, interest payments, and short-term debt; these, with fiscal balance and current account, characterize gross financing needs and are expected to have a positive impact on spreads.
  - External solvency indicators: current account and trade openness (exports + imports to GDP) expected to have negative signs.
- Financial fragility and crisis-period measurement:
  - The Emerging Markets Financial Stress Index (Balakrishnan et al. 2009) is used to capture intensity of stress; components include:
    - Exchange market pressure index (increases as exchange rate depreciates or reserves decline)
    - Default risk measures (sovereign bond spreads) — note: in all estimations the index is modified by excluding its sovereign bond spread component to avoid endogeneity
    - Banking sector beta (12-month rolling window)
    - Stock price returns (calibrated so falling prices = increased stress)
    - Time-varying stock return volatility
  - Political instability is included as a variable expected to widen sovereign bond spreads.
- Data description (verbatim as provided):
  - The data set covers 14 countries between the first quarter of 1997 and the second quarter of

_This content unit is drawn from the supplied IMF chapter PDF excerpt._

### 2009. The dependent variable is the secondary market spread, as provided by JPMorgan’s

### _wp10281 - 2009. The dependent variable is the secondary market spread, as provided by JPMorgan’s

### Data and variable construction
- Dependent variable: secondary market spreads from JPMorgan’s Emerging Markets Bond Index (EMBI); spread measured as the premium paid by an emerging market over a U.S. government bond with comparable maturity features; country spread index = market-capitalization-weighted average of included instruments (continuous time series).
- Right-hand-side variables: country-specific macroeconomic fundamentals, external liquidity indicators, political risk and financial stress indices.
- Data sources: IMF International Financial Statistics database, IMF Global Data Source, Haver Statistics database, World Bank database, Bloomberg (JPMorgan EMBIG Index), The Economist Intelligence Unit (political risk), Balakrishnan and others (financial stress index), CBOE (VIX), Federal Reserve (U.S. rates).
- Key variables and measurement units (excerpt from Table 1):
  - Spreads: Basis Points, Quarterly, Bloomberg (JPMorgan EMBIG Index)
  - GDP: Dollars, Quarterly
  - External debt: Dollars, Annual (interpolated)
  - Public debt: Percent (stock of public debt to GDP), Annual (interpolated)
  - Short-term debt: Dollars, Annual (interpolated)
  - Interest (payments on external debt): Dollars, Annual (interpolated)
  - Reserves: Dollars, Quarterly
  - Amortization (principal repayments on external debt): Dollars, Quarterly
  - Fiscal balance: Percent (fiscal balance to GDP), Quarterly
  - Current account: Dollars, Quarterly
  - Political risk index: Index (0–100), Quarterly
  - Financial stress index: None, Quarterly
  - VIX: Index, Quarterly
  - U.S. 3-month Treasury bill rate: Percent, Quarterly
  - U.S. 10-year government bond rate: Percent, Quarterly

### Summary statistics and correlations (selected)
- Summary statistics (Table 2 highlights):
  - EMBI Spread observations: 988 (All countries mean listed by country; example per-country means shown)
  - VIX mean: 21.497 (988 observations)
  - U.S. 3-month Treasury bill rate mean: 0.039 (1,404 observations)
  - U.S. 10-year government bond yield mean: 0.057 (1,404 observations)
- Pairwise correlations (Table 2 / Figure 1 findings):
  - EMBI spreads are highly positively correlated with external debt (External debt/GDP) and public debt (Public debt/GDP).
  - Interest payments/reserves, short-term debt/reserves, and amortization/reserves are positively correlated with EMBI spreads.
  - Political risk index and financial stress index are positively correlated with EMBI spreads.
  - Fiscal balance and current account are not highly correlated with spreads.
  - High positive correlation between ratios of external and public debt: 0.8.
  - Liquidity measures (short-term debt, interest payments, amortization to reserves) are highly correlated among themselves.

### Calibration and model specification
- Econometric approach:
  - Use of pooled mean group (PMG) estimator of Pesaran and Smith (1995) and Pesaran, Shin, and Smith (1999) to capture quarterly frequency panel data.
  - PMG distinguishes short-term from long-term parameters, allows short-term parameters to vary across countries while keeping long-term elasticities constant.
  - Advantages noted: controls for cointegration, imposes commonality on long-run coefficients, allows short-run country specificity.
- Models estimated:
  - Basic log fixed-effects model: sum_j x_jit + alpha_i + epsilon_it form (equation (6) representation).
  - Dynamic error-correction representation incorporating lagged dependent variables and long-run commonality (equation (7)) estimated via PMG.

### Fixed-Effects estimation (key findings from Table 3 and text)
- Benchmark specification (specification 2) includes all variables; reported explanatory power: R^2 = 0.824.
- Significant coefficients and signs (benchmark/specifications summary):
  - External debt/GDP coefficient ≈ 2.811*** (specification 2); across specifications coefficients reported include 2.856***, 2.811***, 2.626***, 2.813***, 2.915***, 2.809***, 2.795*** (standard errors in parentheses).
  - Interest payments/reserves coefficients significant and positive in relevant specifications: e.g., 2.055*** (std. err. (0.268)) and variants.
  - Amortization/reserves often negative and significant: e.g., -0.499***, -0.599***, -0.597***, -0.604***.
  - Political risk index positive and significant: e.g., 0.0185*** (specification 2).
  - Openness negative and significant: e.g., -0.737*** (specification 2).
  - Financial stress index positive and significant: e.g., 0.047*** (specification 2).
  - VIX positive and significant across specifications: e.g., 0.0372*** (specification 2).
- Global U.S. rate effects (specification sensitivity):
  - When some domestic liquidity variables excluded, U.S. 3-month Treasury bill rate and term spread become large and significant:
    - A 1 percentage point increase in the 3-month Treasury bill rate increases EMBI spreads by about 7.463*** percentage points (reported in specification 5).
    - A 1 percentage point increase in the term spread between the 10-year U.S. government bond and the 3-month Treasury bill increases spreads by 7.121** (specification 5).
- Interpretation:
  - Sum of liquidity indicators positive → greater financing needs relative to liquid resources increase sovereign bond spreads.
  - Fiscal balance not consistently significant across specifications; an increase in debt-to-GDP by 1 percentage point increases spreads by about 2.8 basis points (textual estimate).
  - Financial stress index adds explanatory power: exclusion reduces R^2 by 5 percentage points.

### Pooled Mean Group (PMG) estimation (key findings from Table 4 and text)
- Long-run vs short-run:
  - PMG results indicate important long-run relationships for fundamentals; short-run dynamics differ across countries.
  - Error correction coefficient (phi) in benchmark equation (2): -0.532*** (std. err. (0.094)); average error correction coefficient reported as -0.53 in text, implying about 50 percent of adjustment to steady state each quarter and about 95 percent dissipation of a shock within a year.
- Selected long-term coefficients (specification 2 and variants):
  - External debt/GDP long-term coefficients include 2.205*** (specification 2) and other reported values (e.g., 2.655***, 5.779***, 1.404***, 2.537***, 2.238***, 2.088*** with standard errors shown).
  - Interest payments/reserves long-term: 6.754*** (specification 2) and other significant estimates (e.g., 6.497***).
  - Amortization/reserves long-term: -1.520*** (specification 2) and similar negative long-run coefficients.
  - Fiscal balance/GDP long-term: 3.258*** (specification 2).
  - Current account/GDP long-term: -3.278*** (specification 2).
  - Political risk index long-term: 0.018*** (specification 2).
  - Openness long-term: -0.396 (specification 2) with significance in other specs (e.g., -4.879*** in specification 3).
  - VIX long-term: 0.026*** (specification 2).
  - U.S. 3-month Treasury bill rate and term spread show positive and significant long-term coefficients in specifications where domestic liquidity variables are used one at a time (examples: 13.97***, 12.14*** in some specifications).
- Short-term coefficients (selected):
  - Financial stress index is significant in the short run: e.g., 0.011* to 0.014*** across specifications.
  - VIX is also significant in the short run: e.g., 0.020*** (specification 2).
  - Political risk index short-term coefficients often negative or small and sometimes significant at conventional levels (e.g., -0.009** in one specification).
  - Openness shows positive short-term coefficients in some specifications (e.g., 1.627***, 1.700***).
- Interpretation:
  - Fundamentals (debt ratios, liquidity indicators, political risk, trade openness) determine steady-state (long-run) sovereign spread levels.
  - Financial stress and global volatility (VIX) have important short-run effects; financial stress is largely transitory with rapid dissipation implied by phi.
  - PMG estimates support a strong long-term role for macroeconomic fundamentals, while short-run variation is substantially affected by country-specific financial fragility.

### Discussion of results and implications
- Main empirical regularities:
  - Strong long-term relationship between emerging market sovereign spreads and macro fundamentals: debt and debt-related variables, trade openness, liquidity conditions, political risk.
  - Short-run variation in sovereign spreads is more strongly influenced by financial fragility (financial stress index) and global volatility (VIX).
- Policy-relevant implications implied by results:
  - Managing debt levels and debt-related flows matters for long-term sovereign borrowing costs.
  - Maintaining adequate reserves and managing short-term external liabilities can reduce liquidity-driven spreads.
  - Political risk mitigation (stability, governance) contributes to lower long-run spreads.
  - Country-specific financial stability policies can mitigate short-run spikes in spreads, given the transitory but strong short-term effect of financial stress.
  - Global monetary and yield-curve conditions (U.S. short-term rates and term spread) can materially affect emerging market spreads, particularly when domestic liquidity cushions are weak.

### Concluding remarks
- Methodological contribution: combined use of fixed-effects and PMG estimation allows distinction between short- and long-term determinants while accommodating country-specific short-run dynamics.
- Empirical conclusions:
  - Short run: financial fragility and liquidity conditions (including global volatility) are major determinants of sovereign spreads.
  - Long run: macroeconomic fundamentals (debt dynamics, current account, openness) and political risk are significant determinants of sovereign spreads.
- Consistency with literature: findings align with Ferrucci (2003) and extend Mody (2009) by highlighting the short-run importance of financial stress beyond simple crisis dummy variables.

*Source: Authors.*

### References

### References

### Works on sovereign spreads, emerging markets, and financial contagion
- Balakrishnan, Ravi, Stephan Danninger, Selim Elekdag, and Irina Tytell, 2009, “The Transmission of Financial Stress from Advanced to Emerging Economies,” IMF Working Paper No. 09/133 (Washington: International Monetary Fund).
- Baldacci, Emanuel, Sanjeev Gupta, and Amine Mati, 2008, “Is It (Still) Mostly Fiscal? Determinants of Sovereign Spreads in Emerging Markets,” IMF Working Paper No. 08/259 (Washington: International Monetary Fund).
- Bordo, Michael D., Christopher M. Meissner, and M. D. Weidenmier, 2009, “Identifying the Effects of an Exchange Rate Depreciation on Country Risk: Evidence from a Natural Experiment,” Journal of International Money and Finance, Vol. 28, Issue 6, pp. 1022–44.
- Caceres, Carlos, Vincenzo Guzzo, and Miguel Segoviano, 2010, “Sovereign Spreads: Global Risk Aversion, Contagion or Fundamentals?” IMF Working Paper No. 10/120 (Washington: International Monetary Fund).
- Dailami, Mansur, Paul R. Masson, and Jean Jose Padou, 2008, “Global Monetary Conditions versus Country-Specific Factors in the Determination of Emerging Market Debt Spreads,” Journal of International Money and Finance, Vol. 27, Issue 8, pp. 1325–36.
- Ebner, Alexander, 2009, “An Empirical Analysis on the Determinants of CEE Government Bond Spreads,” Emerging Market Review, Vol. 10, pp. 97–121.
- Eichengreen, Barry, and Ashoka Mody, 1998, “What Explains Changing Spreads on EM Debt: Fundamentals or Market Sentiment?” NBER Working Paper 6408 (Cambridge, Mass.: National Bureau of Economic Research).
- Ferrucci, Gianluigi, 2003, “Empirical Determinants of Emerging Market Economies’ Sovereign Bond Spreads,” Working Paper No. 205 (London: Bank of England).
- Goldman Sachs, 2000, “A New Framework for Assessing Fair Value in Ems’ Hard Currency Debt,” Global Economics Paper, Vol. 45, New York.
- Kamin, Steve B., and Karsten Von Kleist, 1999, “The Evolution and Determinants of EM Credit Spreads in the 1990s,” International Finance Discussion Paper No. 653 (Basel: Bank for International Settlements).
- McGee, Christopher Dylan, 2007, “Sovereign Bond Market with Political Risk and Moral Hazard,” International Review of Economics & Finance, Vol. 16, Issue 2, pp. 186-201.
- Min, Hong-Ghi. G., 1998, “Determinants of EM Bond Spread: Do Economic Fundamentals Matter?” Working Paper in International Economics, Trade, and Capital Flows No. 1899 (Washington: The World Bank).
- Mody, Ashoka, 2009, “From Bear Stearns to Anglo Irish: How Eurozone Sovereign Bond Spreads Related to Financial Sector Vulnerability,” IMF Working Paper No. 09/108 (Washington: International Monetary Fund).

### Methodology, econometrics, and monetary transmission
- Baltagi, H. Badi, and James M. Griffin, 1997, “Pooled Estimators vs. Their Heterogeneous Counterparts in the Context of Dynamic Demand for Gasoline,” Journal of Econometrics, Vol. 77, Issue 2, pp. 303–27.
- Boyd, Derick, and Ron Smith, 2002, Some Econometric Issues in Measuring the Monetary Transmission Mechanism, with an Application to Developing Countries, in Monetary Transmission in Diverse Economies, ed. by Lavan Mahadeva and Peter Sinclair (Cambridge University Press, United Kingdom), pp. 68–99.
- Dell’Ariccia, Giovanni, Isabel Goedde, and Jeromin Zettelmeyer, 2000, “Moral Hazard in International Crisis Lending: A Test,” IMF Working Paper No. 02/181 (Washington: International Monetary Fund).
- Pesaran, M. Hashem, and Ron Smith, 1995, “Estimating Long-Run Relationships from Dynamic Heterogeneous Panels,” Journal of Econometrics, Vol. 68, Issue 1, pp. 79-113.
- Pesaran, M. Hashem, Yongcheol Shin, and Ron P. Smith, 1999, Pooled Mean Group Estimation of Dynamic Heterogeneous Panels. ESE Discussion Paper (Edinburgh: Edinburgh School of Economics, University of Edinburgh).

### Country risk models and institutional data sources
- The Economist Intelligence Unit, 2009, Country Risk Model (various issues), London. https://eiu.bvdep.com/version-2010728/cgi/template.dll?product=105&user=ipaddress.
- International Monetary Fund, 2009a, Global Development Statistics (Washington).
- International Monetary Fund, 2009b, International Financial Statistics (Washington).
- International Monetary Fund, 2009c, World Economic Outlook, World Economic and Financial Surveys (Washington: April).
- World Bank, 2009, Global Development Finance (Washington: The World Bank).

*Source: _wp10281 - References*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2010/_wp10281.pdf_