Spillovers Between Sovereign CDS, Exchange Rate and Market Fear: Evidence From Latin America

This study examines the spillover effects among sovereign Credit Default Swap (CDS) markets, exchange rates, and market fear in Latin America. Using a Time-Varying Parameter Vector Autoregressive (TVP-VAR) model, we identify significant spillovers among these markets. Sovereign CDS spreads from Colombia, Mexico, and Peru are the main transmitters of risk, while the US dollar and Euro act as dominant sources of volatility in exchange rate markets. The results reveal a bidirectional relationship between market fear, measured by the VIX and OVX indices, and CDS and exchange rates. These interactions increase vulnerability during periods of global uncertainty, emphasizing the need for macroprudential policies to manage financial risks in emerging economies. The findings contribute to the understanding of financial contagion in Latin America and offer policy insights into mitigating external financial shocks.