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News and sovereign default risk in small open economies

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  • Ricardo Nunes

    (Federal Reserve Board)

  • Horacio Sapriza

    (Federal Reserve Board)

  • Bora Durdu

    (Federal Reserve Board)

Abstract

This paper builds a model of sovereign debt in which default risk, interest rates, and debt depend not only on current fundamentals but also on news about future fundamentals. News shocks affect equilibrium outcomes because they contain information about the future ability of the government to repay its debt. First, in the model with news shocks not all defaults occur in bad times, bringing the model closer to the data. Second, the news shocks help account for key differences between emerging markets and developed economies: a higher precision of news about future fundamentals lowers the uncertainty that agents face and partially completes financial markets. As the precision of news improves, the model predicts lower variability of consumption, less countercyclical trade balance and interest rate spreads, as well as a higher level of debt more in line with the characteristics of developed economies. Finally, the model also captures the hump-shaped relationship between default rates and the precision of news obtained from the data.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1355.

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Date of creation: 2011
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Handle: RePEc:red:sed011:1355

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Citations

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Cited by:
  1. 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.
  2. Leonardo Martinez & Juan Hatchondo & Javier Bianchi, 2012. "Sovereign defaults and optimal reserves management," 2012 Meeting Papers, Society for Economic Dynamics 1125, Society for Economic Dynamics.
  3. Fabian Fink & Almuth Scholl, 2011. "A Quantitative Model of Sovereign Debt, Bailouts and Conditionality," Working Paper Series of the Department of Economics, University of Konstanz, Department of Economics, University of Konstanz 2011-46, Department of Economics, University of Konstanz.
  4. Christopher M. Gunn & Alok Johri, 2013. "Fear of Sovereign Default, Banks, and Expectations-Driven Business Cycles," Carleton Economic Papers, Carleton University, Department of Economics 13-03, Carleton University, Department of Economics.
  5. Juan Carlos Hatchondo & Leonardo Martinez & Cesar Sosa-Padilla, 2014. "Debt Dilution and Sovereign Default Risk," Department of Economics Working Papers 2014-06, McMaster University.
  6. Leonardo Martinez & Cesar Sosa Padilla & Juan Hatchondo, 2012. "Debt dilution and sovereign default risk," 2012 Meeting Papers, Society for Economic Dynamics 974, Society for Economic Dynamics.

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