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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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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. Carmen M. Reinhart, 2002. "Default, Currency Crises and Sovereign Credit Ratings," NBER Working Papers 8738, 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, Econometric Society, vol. 59(2), pages 371-96, March.
  3. 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.
  4. Correia, Maria Isabel Horta & Neves, Joao C & Rebelo, Sérgio, 1994. "Business Cycles in a Small Open Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 996, C.E.P.R. Discussion Papers.
  5. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, American Economic Association, vol. 81(4), pages 797-818, September.
  6. Zhang, Harold H, 1997. " Endogenous Borrowing Constraints with Incomplete Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 52(5), pages 2187-2209, December.
  7. Cole, Harold L & Dow, James & English, William B, 1995. "Default, Settlement, and Signalling: Lending Resumption in a Reputational Model of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 365-85, May.
  8. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  9. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 17(5-6), pages 953-969.
  10. Pablo A. Neumeyer & Fabrizio Perri, 2004. "Business cycles in emerging economies: the role of interest rates," Staff Report, Federal Reserve Bank of Minneapolis 335, Federal Reserve Bank of Minneapolis.
  11. 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, Inter-American Development Bank, Research Department 4307, Inter-American Development Bank, Research Department.
  12. Guillermo Larraín & Helmut Reisen & Julia von Maltzan, 1997. "Emerging Market Risk and Sovereign Credit Ratings," OECD Development Centre Working Papers 124, OECD Publishing.
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Cited by:
  1. 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.
  2. 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, Inter-American Development Bank, Research Department 4307, Inter-American Development Bank, Research Department.
  3. Daniel A. Dias & Christine J. Richmond & Mark L.J. Wright, 2011. "The Stock of External Sovereign Debt: Can We Take the Data At ‘Face Value’?," NBER Working Papers 17551, National Bureau of Economic Research, Inc.
  4. Franz Hamann, 2002. "Sovereign Risk And Real Business Cycles In A Small Open Economic," BORRADORES DE ECONOMIA 003521, BANCO DE LA REPÚBLICA.
  5. Irwin, Gregor & Thwaites, Gregory, 2008. "Efficient frameworks for sovereign borrowing," Bank of England working papers, Bank of England 343, Bank of England.
  6. 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.
  7. Enrique G. Mendoza, 2002. "Why Should Emerging Economies Give Up National Currencies?: A Case for "Institutions Substitution"," IDB Publications 6822, Inter-American Development Bank.
  8. Mauricio A. Hernández & Munir A. Jalil B. & Carlos Esteban Posada, 2005. "El costo de los ciclos económicos en Colombia: una nueva Estimación," BORRADORES DE ECONOMIA 002478, BANCO DE LA REPÚBLICA.
  9. Mark Aguiar & Manuel Amador, 2013. "Sovereign Debt: A Review," NBER Working Papers 19388, National Bureau of Economic Research, Inc.
  10. 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, Inter-American Development Bank, Research Department 4308, Inter-American Development Bank, Research Department.
  11. Michael Tomz & Mark L.J. Wright, 2013. "Empirical Research on Sovereign Debt and Default," Annual Review of Economics, Annual Reviews, Annual Reviews, vol. 5(1), pages 247-272, 05.
  12. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets," Working Papers, Banco de México 2006-01, Banco de México.
  13. Joost Röttger, 2014. "Monetary and Fiscal Policy with Sovereign Default," Working Paper Series in Economics, University of Cologne, Department of Economics 74, University of Cologne, Department of Economics.
  14. Enrique Mendoza, 2002. "¿Por qué deben las economías emergentes renunciar a su moneda nacional? El argumento a favor," Research Department Publications, Inter-American Development Bank, Research Department 4310, Inter-American Development Bank, Research Department.

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