DP3785 Learning to Forget? Contagion and Political Risk in Brazil

Author(s): Marcus Miller, Kannika Thampanishvong, Lei Zhang
Publication Date: February 2003
Keyword(s): bayesian learning, political risk, sovereign spreads, time-consistency
JEL(s): E61, E62, F34
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3785

We examine whether Brazilian sovereign spreads of over 20% in 2002 could be due to contagion from Argentina or to domestic politics, or both. Treating unilateral debt restructuring as a policy variable gives rise to the possibility of self-fulfilling crisis, which can be triggered by contagion. We explore an alternative political-economy explanation of panic in financial markets inspired by Alesina (1987), which stresses exaggerated market fears of an untried Left-wing candidate. To account for the fall of sovereign spreads since the election, we employ a model of Bayesian learning and analyse the effects of contagion and IMF commitments.