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Learning to Forget? Contagion and Political Risk in Brazil

Marcus Miller, Kannika Thampanishvong, Lei Zhang

CSGR Working Paper No. 113/03

February 2003



We examine whether Brazilian sovereign spreads of over 20 percent in 2002 could be due to contagion from Argentina or to domestic politics, or both. Treating unilateral debt restructuring as a policy variable gives rise to the possibility of self-fulfilling crisis, which can be triggered by contagion. We explore an alternative political-economy explanation of panic in financial markets inspired by Alesina (1987), which stresses exaggerated market fears of an untried Left-wing candidate. To account for the fall of sovereign spreads since the election, we employ a model of Bayesian learning and analyse the effects of contagion and IMF commitments.

Keywords: Sovereign Spreads, Political Risk, Bayesian Learning, Time-Consistency

JEL Classifications: E61, E62, F34.


Address for correspondence

Marcus Miller, CEPR  Kannika Thampanishvong
Department of Economics Department of Economics
Warwick University Warwick University
Coventry, CV4 7AL Coventry, CV4 7AL
E-mail: E-mail:
Tel. ( 44 203) 523 049

Lei Zhang
Department of Economics
Warwick University
Coventry, CV4 7AL

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