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A Solution to the Default Risk-Business Cycle Disconnect

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Author Info
Enrique G. Mendoza
Vivian Z. Yue

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Abstract

We propose a model that solves the crucial disconnect between business cycle models that treat default risk as an exogenous interest rate on working capital, and sovereign default models that treat output fluctuations as an exogenous process with ad-hoc default costs. The model replicates observed output dynamics around defaults, countercyclical spreads, high debt ratios, and key business cycle moments. Three features of the model are central for these results: working capital loans pay for imported inputs; default triggers an efficiency loss as imported inputs are replaced by imperfect domestic substitutes; and default on public and private foreign obligations occurs simultaneously.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13861.

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Date of creation: Mar 2008
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Handle: RePEc:nbr:nberwo:13861

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Find related papers by JEL classification:
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
  5. Cuadra, Gabriel & Sapriza, Horacio, 2008. "Sovereign default, interest rates and political uncertainty in emerging markets," Journal of International Economics, Elsevier, vol. 76(1), pages 78-88, September. [Downloadable!] (restricted)
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  6. Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany. [Downloadable!]
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  7. Arteta, Carlos & Hale, Galina, 2008. "Sovereign debt crises and credit to the private sector," Journal of International Economics, Elsevier, vol. 74(1), pages 53-69, January. [Downloadable!] (restricted)
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  8. Felipe Meza & Erwan Quintin, 2005. "Financial crises and total factor productivity," Center for Latin America Working Papers 0105, Federal Reserve Bank of Dallas. [Downloadable!]
  9. Enrique G. Mendoza, 2006. "Endogenous Sudden Stops in a Business Cycle Model with Collateral Constraints:A Fisherian Deflation of Tobin's Q," NBER Working Papers 12564, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  12. Michael Tomz & Mark L. J. Wright, 2007. "Do Countries Default in "Bad Times" ?," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 352-360, 04-05. [Downloadable!] (restricted)
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  13. Cristina Arellano & Narayana R. Kocherlakota, 2008. "Internal Debt Crises and Sovereign Defaults," NBER Working Papers 13794, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Oviedo, P. Marcelo, 2005. "World Interest Rate, Business Cycles, and Financial Intermediation in Small Open Economies," Staff General Research Papers 12360, Iowa State University, Department of Economics. [Downloadable!]
  15. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, vol. 69(1), pages 6-36, June. [Downloadable!] (restricted)
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  18. Ugo Panizza & Eduardo Levy Yeyati, 2006. "The Elusive Costs of Sovereign Defaults," RES Working Papers 4485, Inter-American Development Bank, Research Department. [Downloadable!]
  19. Gita Gopinath & Oleg Itskhoki & Roberto Rigobon, 2007. "Currency Choice and Exchange Rate Pass-through," NBER Working Papers 13432, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  21. Ran Bi, 2008. "Beneficial Delays in Debt Restructuring Negotiations," IMF Working Papers 08/38, International Monetary Fund. [Downloadable!]
  22. Guido Sandleris & Gaston R. Gelos & Ratna Sahay, 2004. "Sovereign Borrowing by Developing Countries: What Determines Market Access?," IMF Working Papers 04/221, International Monetary Fund.
    Other versions:
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond. [Downloadable!]
  2. Juan M. Sanchez, 2009. "The role of information in the rise in consumer bankruptcies," Working Paper 09-04, Federal Reserve Bank of Richmond. [Downloadable!]
  3. Cristina Arellano & Narayana Kocherlakota, 2008. "Internal Debt Crises and Sovereign Defaults," Levine's Bibliography 122247000000001880, UCLA Department of Economics. [Downloadable!]
    Other versions:
  4. Christoph Trebesch, 2009. "The Cost of Aggressive Sovereign Debt Policies: How Much is thePrivate Sector Affected?," IMF Working Papers 09/29, International Monetary Fund. [Downloadable!]
  5. Emine Boz, 2009. "Sovereign Default, Private Sector Creditors and the IFIs," IMF Working Papers 09/46, International Monetary Fund. [Downloadable!]
  6. Bertrand Gruss & Karel Mertens, 2009. "Regime Switching Interest Rates and Fluctuations in Emerging Markets," Economics Working Papers ECO2009/22, European University Institute. [Downloadable!]
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