Co‐Movement of Political Risk and Sovereign Credit Risk: A Wavelet Coherence Analysis for Argentina, Brazil, and Venezuela

Objective This article aim to investigate the causal relationship between sovereign credit risk and political risk in Argentina, Brazil, and Venezuela. Methods Granger causality, Toda Yamamoto causality, and wavelet coherence tests are used to answer the following questions: (i) Is there are causal linkage between sovereign credit risk and political risk? (ii) If yes, in which direction(s)? It also provides a recent literature on the methods of quantification of political risk and historic economic instabilities in the selected countries. Results The findings from wavelet coherence reveal that (i) between 1997 and 2005, sovereign credit risk significantly causes political risk in Argentina at medium frequency but between 2008 and 2015, at high frequency, the direction of causality is opposite relative to the previous period; (ii) the correlation between political risk and sovereign credit risk is not high throughout the period of 1993‐2015, although there is a positive correlation between sovereign credit risk and political risk 1998 and 2000 at only high frequency in Brazil; (iii) between 1997 and 2011, political risk significantly causes sovereign credit risk in Venezuela. At high frequency, between 2006 and 2007, there is also positive correlation between sovereign credit risk and political risk. Conclusion There is evidence that there is a feedback causal relationship between political risk and sovereign credit risk at different frequencies.