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Default Risk and Income Fluctuations in Emerging Economies

  • Cristina Arellano

Recent sovereign defaults are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default is more likely in recessions because this is when it is more costly for a risk averse borrower to repay noncontingent debt. The model closely matches business cycles in Argentina predicting high volatility of interest rates, higher volatility of consumption relative to output, and negative correlations of output with interest rates and the trade balance.

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.98.3.690
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File URL: http://www.aeaweb.org/aer/data/june08/20050350_data.zip
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 98 (2008)
Issue (Month): 3 (June)
Pages: 690-712

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Handle: RePEc:aea:aecrev:v:98:y:2008:i:3:p:690-712
Note: DOI: 10.1257/aer.98.3.690
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  1. Martin Uribe & Vivian Z. Yue, 2003. "Country Spreads and Emerging Countries: Who Drives Whom?," NBER Working Papers 10018, National Bureau of Economic Research, Inc.
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  7. Harold L. Cole & Patrick J. Kehoe, 1997. "Reviving reputation models of international debt," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 21-30.
  8. Jean Tirole, 2003. "Inefficient Foreign Borrowing: A Dual- and Common-Agency Perspective," American Economic Review, American Economic Association, vol. 93(5), pages 1678-1702, December.
  9. Pablo Neumeyer & Fabrizio Perri, 2004. "Business cycles in emerging economies: the role of interest rates," Staff Report 335, Federal Reserve Bank of Minneapolis.
  10. Fernando Broner & Guido Lorenzoni & Sergio L. Schmukler, 2003. "Why do emerging economies borrow short term?," Economics Working Papers 838, Department of Economics and Business, Universitat Pompeu Fabra, revised Dec 2011.
  11. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
  12. 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.
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  15. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  16. Manuel Amador, 2004. "A Political Model Sovereign Debt Repayment," 2004 Meeting Papers 762, Society for Economic Dynamics.
  17. 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.
  18. Guido M. Sandleris, 2005. "Sovereign Defaults: Information, Investment and Credit," 2005 Meeting Papers 21, Society for Economic Dynamics.
  19. 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.
  20. 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.
  21. Mark Aguiar & Gita Gopinath, 2007. "Emerging Market Business Cycles: The Cycle Is the Trend," Journal of Political Economy, University of Chicago Press, vol. 115, pages 69-102.
  22. Daniel Cohen & Jeffrey Sachs, 1991. "Growth and External Debt Under Risk of Debt Repudiation," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 437-472 National Bureau of Economic Research, Inc.
  23. Jeremy I. Bulow & Kenneth Rogoff, 1988. "Sovereign Debt: Is To Forgive To Forget?," NBER Working Papers 2623, National Bureau of Economic Research, Inc.
  24. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  25. Gelos, R. Gaston & Sahay, Ratna & Sandleris, Guido, 2011. "Sovereign borrowing by developing countries: What determines market access?," Journal of International Economics, Elsevier, vol. 83(2), pages 243-254, March.
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