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Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets

  • Gabriel Cuadra
  • Horacio Sapriza

Emerging economies tend to experience larger fluctuations in their terms of trade, countercyclical interest rates and more default episodes than developed countries. These structural features might suggest a relevant role for world prices in driving country spreads. This paper studies the role of terms of trade shocks in inducing output fluctuations and countercyclical spreads using a stochastic dynamic general equilibrium model of a small open economy. The model predicts that default incentives and default premia are higher in recessions, as observed in the data. In a quantitative exercise, the model matches various features of emerging economies and can account for the dynamics of default episodes in these markets.

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Paper provided by Banco de México in its series Working Papers with number 2006-01.

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Date of creation: Feb 2006
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Handle: RePEc:bdm:wpaper:2006-01
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