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Balance sheet effects and the country risk premium: an empirical investigation

Author

Listed:
  • Juan Carlos Berganza

    (Banco de España)

  • Roberto Chang

    (Rutgers University)

  • Alicia García Herrero

    (Banco de España)

Abstract

This paper investigates empirically whether there is a negative relationship between a country's risk premium and the balance sheet effect, as implied by recent theories emphasizing financial imperfections. We find evidence that balance sheet effects, stemming from the increase in the external debt service after an unexpected real depreciation, significantly raise the risk premium. We also show that the increase in the risk premium is not due to the debt service as such. While the result holds for the whole sample, we show that it is mainly driven by those countries with the largest financial imperfections, as argued by imperfect capital market theories. Particularly large real depreciations also seem to be disproportionately important, meaning that the balance sheet effects may be strongest at times of economic crisis, when large devaluations occur.

Suggested Citation

  • Juan Carlos Berganza & Roberto Chang & Alicia García Herrero, 2003. "Balance sheet effects and the country risk premium: an empirical investigation," Working Papers 0316, Banco de España.
    • Handle: RePEc:bde:wpaper:0316
    as

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    2. García, Carlos J. & González, Wildo D., 2013. "Exchange rate intervention in small open economies: The role of risk premium and commodity price shocks," International Review of Economics & Finance, Elsevier, vol. 25(C), pages 424-447.
    3. Óscar J. Arce, 2005. "The fiscal theory of the price level: a narrow theory for non-fiat money," Working Papers 0501, Banco de España.
    4. Emiliano Libman, 2019. "Destabilizing Balance Sheet Effects in the New Consensus Model," Eastern Economic Journal, Palgrave Macmillan;Eastern Economic Association, vol. 45(4), pages 590-611, October.
    5. Brei, Michael & Buzaushina, Almira, 2015. "International financial shocks in emerging markets," Journal of International Money and Finance, Elsevier, vol. 58(C), pages 51-74.
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    7. Aysun, Uluc, 2008. "Automatic stabilizer feature of fixed exchange rate regimes," Emerging Markets Review, Elsevier, vol. 9(4), pages 302-328, December.
    8. Vanessa Olakemi Dovonou, 2023. "Trilemma revisited with dollar dominance in trade and finance," Working Papers 2023.05, International Network for Economic Research - INFER.
    9. Camilo E Tovar, 2006. "Devaluations, output and the balance sheet effect: a structural econometric analysis," BIS Working Papers 215, Bank for International Settlements.
    10. Schweickert, Rainer & Thiele, Rainer, 2004. "From Washington to post-Washington? Consensus policies and divergent developments in Latin America and Asia," Kiel Discussion Papers 408, Kiel Institute for the World Economy (IfW Kiel).
    11. Tkalec, Marina & Vizek, Maruška & Verbič, Miroslav, 2014. "Balance sheet effects and original sinners’ risk premiums," Economic Systems, Elsevier, vol. 38(4), pages 597-613.
    12. Hossein Bastanzad & Pedram Davoudi & Hossein Tavakolian, 2018. "Foreign Exchange Rate Pricing at the Future Contract (Case of I.R. of Iran)," Iranian Economic Review (IER), Faculty of Economics,University of Tehran.Tehran,Iran, vol. 22(1), pages 253-293, Winter.
    13. Uluc Aysun, 2006. "Automatic Stabilizer Feature of Fixed Exchange Rate Regimes in Emerging Markets," Working papers 2006-27, University of Connecticut, Department of Economics, revised Aug 2008.
    14. Sokolov, Vladimir, 2010. "Bi-currency versus single-currency targeting : lessons from the Russian experience," BOFIT Discussion Papers 7/2010, Bank of Finland, Institute for Economies in Transition.
    15. Mihai Copaciu & Joana Madjoska & Mite Miteski, 2021. "A DSGE Model with Partial Euroization: The Case of the Macedonian Economy," Economy, Business & Development: An International Journal, Ss. Cyril and Methodius University in Skopje, Faculty of Economics-Skopje, vol. 2(2), pages 57-118, November.
    16. Petra Palic & Petra Posedel Simovic & Maruska Vizek, 2017. "The Determinants of Country Risk Premium Volatility: Evidence from a Panel VAR Model," Croatian Economic Survey, The Institute of Economics, Zagreb, vol. 19(1), pages 37-66, June.
    17. Rasaki, Mutiu Gbade & Malikane, Christopher, 2017. "An estimated financial accelerator model for small-open African economies," MPRA Paper 95977, University Library of Munich, Germany.
    18. Rasaki, Mutiu Gbade & Malikane, Christopher, 2015. "Macroeconomic shocks and fluctuations in African economies," Economic Systems, Elsevier, vol. 39(4), pages 675-696.
    19. Uluc Aysun, 2006. "Testing for Balance Sheet Effects in Emerging Market Countries," Working papers 2006-28, University of Connecticut, Department of Economics.
    20. Sokolov, Vladimir, 2010. "Bi-currency versus single-currency targeting: lessons from the Russian experience," BOFIT Discussion Papers 7/2010, Bank of Finland Institute for Emerging Economies (BOFIT).
    21. Marina Tkalec & Miroslav Verbič, 2013. "A new look into the prevalence of balance sheet or competitiveness effect of exchange rate depreciation in a highly euroised economy," Post-Communist Economies, Taylor & Francis Journals, vol. 25(2), pages 225-240, June.
    22. Uluc Aysun, 2010. "Testing for Balance Sheet Effects in Emerging Markets: A Non‐Crisis Setting," International Finance, Wiley Blackwell, vol. 13(2), pages 223-256, August.
    23. Adela Luque, 2005. "Skill mix and technology in Spain: evidence from firm level data," Working Papers 0513, Banco de España.
    24. Myung-Soo Yie & Byoung Hark Yoo, 2016. "The Role Of Foreign Debt And Financial Frictions In A Small Open Economy Dsge Model," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 61(05), pages 1-23, December.

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    More about this item

    Keywords

    balance sheet effects; country risk premium; sovereign spreads;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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