All for One and One for All?: A Principal Component Analysis of Latin American Brady Bond Debt from 1994 to 2000
Kevin Paul Scherer and Marco Avellaneda
IJTAF 2001

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.