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Default risk and economic activity: A small open economy model with sovereign debt and default

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  • Jessica Roldan-Pena

    (University of California, Los Angeles)

Abstract

Empirical evidence shows that sovereign defaults are associated with significant declines in economic activity in defaulting countries. However, the existing literature on sovereign debt and default mainly analyzes endowment economies and, therefore, does not speak for the interaction between default risk and macroeconomic dynamics. This paper develops a small open economy model with financial frictions, within which output and default risk are jointly determined, that allows to simultaneously examine the behavior of output, consumption and investment and their interaction with sovereign debt and default. When calibrated to match the business cycles properties of an average emerging market economy, the model is able to reproduce the countercyclicality of net exports, the countercyclicality of sovereign spreads and the negative correlation between investment and net exports observed in the data. Furthermore, when analyzing its dynamics around default episodes, the model captures the declines in output, consumption and investment that accompany sovereign defaults.

Suggested Citation

  • Jessica Roldan-Pena, 2011. "Default risk and economic activity: A small open economy model with sovereign debt and default," 2011 Meeting Papers 735, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:735
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    References listed on IDEAS

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    Cited by:

    1. Lopez-Martin, Bernabe & Leal, Julio & Martinez Fritscher, Andre, 2019. "Commodity price risk management and fiscal policy in a sovereign default model," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 304-323.
    2. Park, JungJae, 2017. "Sovereign default and capital accumulation," Journal of International Economics, Elsevier, vol. 106(C), pages 119-133.
    3. Grey Gordon & Pablo Guerron-Quintana, 2018. "Dynamics of Investment, Debt, and Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 71-95, April.

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    More about this item

    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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