On the political determinants of sovereign risk: Evidence from a Markov-switching vector error-correction model for Argentina

While empirical sovereign credit risk models have portrayed default as driven mainly by economic and financial risk factors, this investigation explicitly addresses the relative importance of political risk factors the empirical literature has often overlooked. We use a Markov-switching error-correction model applied to data from the Republic of Argentina to assess the timing and thresholds of the dynamic system, and then test the relation of three risk factors (political, economic and financial) to the sovereign yield spread in a forward-looking representation. The results show the significance of political factors in explaining sovereign risk for Argentina, and demonstrate the feasibility and value of the proposed methodology.