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Sovereign Risk and Macroeconomic Fluctuations

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  • Franz Hamann

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Abstract

This paper investigates the impact of sovereign risk on the stochastic rational expectations equilibrium of a pure exchange small open economy. International borrowing and lending arise from the interaction between a risk averse sovereign representative agent in a small open economy trying to self insure against idiosyncratic shocks and risk neutral international lenders. The credit market is imperfect because the sovereign cannot commit to repay its outstanding debt and chooses to default when it is optimal to do so. The possibility of default induces an endogenous sovereign risk premium on foreign debt and endogenous rationing by foreign creditors. The model is parameterized and solved numerically. The experiments conducted here generalize the results of Eaton and Gersovitz (1981) into environments with varying degrees of persistence and volatility in the underlying stochastic income process.

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Bibliographic Info

Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 003520.

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Length: 31
Date of creation: 30 Nov 2002
Date of revision:
Handle: RePEc:col:000094:003520

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  1. Enrique G. Mendoza & Katherine A. Smith, 2002. "Margin Calls, Trading Costs, and Asset Prices in Emerging Markets: The Finanical Mechanics of the 'Sudden Stop' Phenomenon," NBER Working Papers 9286, National Bureau of Economic Research, Inc.
  2. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  3. Reinhart, Carmen, 2002. "Default, currency crises, and sovereign credit ratings," MPRA Paper 13917, University Library of Munich, Germany.
  4. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
  5. Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995. "Business cycles in a small open economy," European Economic Review, Elsevier, vol. 39(6), pages 1089-1113, June.
  6. Neumeyer, Pablo A. & Perri, Fabrizio, 2005. "Business cycles in emerging economies: the role of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 345-380, March.
  7. Guillermo Larraín & Helmut Reisen & Julia von Maltzan, 1997. "Emerging Market Risk and Sovereign Credit Ratings," OECD Development Centre Working Papers 124, OECD Publishing.
  8. Cristina Arellano & Enrique Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," Research Department Publications 4307, Inter-American Development Bank, Research Department.
  9. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  10. Harold L. Cole & James Dow & William B. English, 1994. "Default, settlement, and signalling: lending resumption in a reputational model of sovereign debt," Staff Report 180, Federal Reserve Bank of Minneapolis.
  11. Zhang, Harold H, 1997. " Endogenous Borrowing Constraints with Incomplete Markets," Journal of Finance, American Finance Association, vol. 52(5), pages 2187-2209, December.
  12. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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Citations

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Cited by:
  1. Enrique Mendoza, 2002. "Why Should Emerging Economies Give Up National Currencies? A Case for Institutions Substitution," Research Department Publications 4309, Inter-American Development Bank, Research Department.
  2. Enrique Mendoza, 2002. "¿Por qué deben las economías emergentes renunciar a su moneda nacional? El argumento a favor," Research Department Publications 4310, Inter-American Development Bank, Research Department.
  3. Michael Tomz & Mark L. J. Wright, 2012. "Empirical research on sovereign debt and default," Working Paper Series WP-2012-06, Federal Reserve Bank of Chicago.
  4. Cristina Arellano & Enrique Mendoza, 2002. "Fricciones crediticias y 'paradas repentinas' en pequeñas economías abiertas: un marco de equilibrio del ciclo económico para crisis en mercados emergentes," Research Department Publications 4308, Inter-American Development Bank, Research Department.
  5. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets," Working Papers 2006-01, Banco de México.
  6. Franz Hamann, 2002. "Sovereign Risk and Real Business Cycles in a Small Open Economy," International Finance 0212001, EconWPA.
  7. Mauricio A. Hernández & Munir A. Jalil & Carlos Esteban Posada, . "El Costo de los Ciclos Económicos en Colombia: Una Nueva Estimación," Borradores de Economia 353, Banco de la Republica de Colombia.
  8. Irwin, Gregor & Thwaites, Gregory, 2008. "Efficient frameworks for sovereign borrowing," Bank of England working papers 343, Bank of England.
  9. Cristina Arellano & Enrique Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," Research Department Publications 4307, Inter-American Development Bank, Research Department.
  10. Wilman Gómez & Carlos Esteban Posada, . "Un "Choque" del Activo Externo Neto y el Ciclo Económico Colombiano," Borradores de Economia 285, Banco de la Republica de Colombia.
  11. Carlos Esteban Posada Posada & Wilman Gómez, 2004. "Un choque del activo externo neto y el ciclo económico Colombiano 1994-2001," BORRADORES DE ECONOMIA 003674, BANCO DE LA REPÚBLICA.
  12. Mark Aguiar & Manuel Amador, 2013. "Sovereign Debt: A Review," NBER Working Papers 19388, National Bureau of Economic Research, Inc.

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