> We can assess more formally the relative role of global and countryspecific

> factors in the observed pattern of capital flows to Argentina and other countries using a

> suitable statistical decomposition separating the common component of sovereign

> spreads from their country-specific component. Loosely speaking, the common component reflects global conditions (both interdependence and 'contagion'), and hence

> captures global risk, while the country-specific component reflects each country's economic fundamentals (or, more precisely, investors' perceptions about them) and thus

> provides a measure of its pure risk premium. 8

This procedure yields a synthetic "global factor", whose role in the observed evolution of emerging-market spreads is depicted in the top panel of Figure 2.6. The figure plots the degree of comovement of the spreads, as measured by the fraction of their total variation (computed over moving 48-month windows) attributable to the global factor. The graph shows that the global factor accounts for the vast majority of the variation in spreads up to 1998. After that date, there is a steady decline in the degree of co-movement of spreads., reversed only in part in September 2001.

The bottom panel of Figure 2.6 performs the same exercise for Argentina, Brazil and Mexico. For each of these countries, the figure shows the fraction of the total variation in its spread attributable to the global factor just described. In all three countries analyzed, sovereign spreads reflect both global and country-specific risk. The roles of these two factors are riot the same across countries and time periods, however. In accordance with the previous figure, the global factor plays the main role up to 1998. Indeed, in 1997-98 it accounts for the bulk of the variation in spreads in all three countries. After the Russia crisis in 1998, however, the contribution of the global factor declines for the three countries. Importantly, the extent of the decline differs aross countries. In the case of Argentina, it is much more marked and accelerates noticeably in the second half of 2000. In fact, after that moment global factors account for less than half of the observed variation in Argentina's spreads. The conclusion is that such variation increasingly reflects country-specific factors after 1998, and especially so from 2000 onward.

> 8The full details are spelled ouat in Fiess (2002). In a nutshell, we use principal component analysis to construct an indicator of global comovement of spreads using end-of-the-month JP Morgan EMBI data for Argentina, Brazil, Mexico, Venezuela and the non-Latin EMBI index over the period from January 1991 to March 2002. The indicator is the percentage of the total variance of the (normalized) spreads explained by their first principal component, constructed using a rolling window of 48 months. We smooth the resulting series by averaging the values obtained for each data point over the 48 windows in which it appears. As a robustness check, we redo the exercise using a broader set of countries - Argentina, Bulgaria, Brazil, Ecuador, Mexico, Nigeria, Panama, Peru, Poland, Russia and Venezuela. However, not all of them possess observations over the entire sample period. We also construct altemative global indicators incorporating the effects of US interest rates on country spreads. Finally, we redo these experiments with alternative window lengths. All these specification changes have only minor effects on the qualitative results. See Fiess (2002) for details.

13