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What makes balance sheet effects detrimental for the country risk premium?

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  • Juan Carlos Berganza

    ()
    (Banco de España)

  • Alicia García-Herrero

    ()
    (Banco de España)

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    Abstract

    This paper builds upon the empirical literature on the macroeconomic impact of real exchange rate depreciations for a sample of 27 emerging economies. We find that real exchange rate depreciations tend to increase a country's risk premium. This effect is neither linear nor symmetric: large real exchange depreciations are much more detrimental and real appreciations do not seem to reduce the risk premium. We also show that the main channels for the real exchange rate to affect country risk are external and domestic balance sheet effects, stemming from the sudden increase in the stock of external or domestic dollar denominated debt, respectively. This is particularly the case in the countries with the largest financial imperfections. Competitiveness is not an important enough factor to outweigh this negative effect. Finally, fixed exchange rate regimes tend to amplify balance sheet effects, beyond the extent of real depreciations. The data indicates that it could be due to a larger accumulation of external debt under fixed regimes.

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    File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/04/Fic/dt0423e.pdf
    File Function: First version, December 2004
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    Bibliographic Info

    Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 0423.

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    Length: 33 pages
    Date of creation: Dec 2004
    Date of revision:
    Handle: RePEc:bde:wpaper:0423

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    Related research

    Keywords: balance sheet effects; financial accelerator theories; exchange rate regime;

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    Cited by:
    1. Eduardo Levy-Yeyati, 2004. "FINANCIAL DOLLARIZATION: Evaluating the consequences," Econometric Society 2004 Latin American Meetings 184, Econometric Society.
    2. Eduardo Levy Yeyati, 2004. "Dollars, Debt and the IFIs: Dedollarizing Multilateral Lending," Business School Working Papers dedollmultlending, Universidad Torcuato Di Tella.
    3. Barbara Fritz & Laurissa Mühlich, 2006. "Regional Monetary Integration among Developing Countries: New Opportunities for Macroeconomic Stability beyond the Theory of Optimum Currency Areas?," GIGA Working Paper Series 38, GIGA German Institute of Global and Area Studies.
    4. Barry Eichengreen, 2006. "Insurance Underwriter or Financial Development Fund: What Role for Reserve Pooling in Latin America?," NBER Working Papers 12451, National Bureau of Economic Research, Inc.

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