Asia-Pacific markets have benefited from an extremely favorable economic climate generated by high global liquidity over the past three years. In 2006, for example, excess liquidity and the generally positive economic performance of these countries led to the lowest sovereign spreads in history falling below 200 basis points, as shown in the chart 1. Mechanisms contributing to this process include: 1) low interest rates in mature markets (US, UK, Europe and Japan), declining until recently due to the breakup of the Internet bubble in 2000; 2) the steep yield curve, which encourages carrying leveraged positions; and 3) low long-term interest rates in the United States relative to the country's economic growth rate. Global liquidity, along with the reduction in risk perception it creates, has encouraged global institutional investors to take strategic positions in Asia-Pacific markets. , thus reducing spreads even further. Additionally, the average credit classification provided by international rating agencies for EMBI+ countries has reached its highest level ever (Ba1/BB+ as of September 2006), further expanding the investor base. This scenario allowed Asia-Pacific economies to finance their debt through local currency issues on domestic and foreign markets, thus allowing them to improve the composition of their public debt by lengthening its maturity profile, reducing the proportion denominated in foreign currencies and by accumulating reserves. .Nevertheless, the crucial question for markets in the Asia-Pacific region is whether the current level of sovereign spreads is sustainable in the face of a potential reversal of cyclical factors, such as those related to liquidity,... ... middle of paper ... ... the dependent variable (interest rate), a common approach to determining sovereign spreads that significantly increases the adjustment coefficient (R2 ). Third, the model uses country-specific macroeconomic fundamentals and governance indicators as explanatory variables, rather than proxies for repayment capacity. These indicators, usually ratings or other holistic constructs, are generally subject to criticism regarding scaling methodology or their ability to predict currency crises in Asia-Pacific economies.5 Additionally, the proposed model analyzes a country's specific vulnerability (sensitivity) to a global risk shock. These elasticities are then decomposed into economic fundamentals and governance indicators, with the aim of assessing whether, and to what extent, the country's vulnerability can be mitigated by improving these variables...