Kevin Paul Scherer and Marco Avellaneda

We use Principal Component Analysis (PCA) to study the Brady Bond Debt of the four primary Latin American sovereign issuers: Argentina, Brazil, Mexico and Venezuela. Our dataset covers a period of 5 1/2 years starting in JUly 1994 and consists of daily sovereign (``stripped'') yield levels for the Par and Discount debt securities of each country. We examine the behavior of the characteristic roots and eigenvectors of the empirical covariance matrices computed sequentially over different periods. We show that, by and large, there exist two statistically significant components, or factors, which explain up to 90% of the realized variance. The eigenvector with the largest eigenvalue corresponds to the variance attributable to ``regional'' (``Latin'') risk. The second component strongly suggests the existence of a volatility risk factor associated to Venezuelan debt in relation to the rest of the region. A time-dependent factor analysis reveals that the importance of the variance explained by the factor changes over time and that this variation can be interpreted to some extent in terms of market events. In particular, we investigate the relation between the evolution of the PCA factors with the market dislocations that occurred during the observation period, including the so-called Tequila effect, Asian flu, Ruble devaluation and Real devaluation.