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Sovereign Risk and Real Business Cycles in a Small Open Economy

  • Franz Hamann

    ()

This paper investigates the effect of sovereign risk on the stochastic rational expectations equilibrium of a real business cycle small open economy.The credit market is imperfect because the sovereign cannot commit to repay its outstanding debt and chooses to default when it is optimal to do so. The possibility of default induces an endogenous sovereign risk premium on foreign debt and an endogenous rationing limit set by foreign creditors. The model is parameterized and solved numerically to explore the determinants of the saving and investment decisions in an economy that can optimally choose to default on its foreign debt and the ability to account for the Sudden Stop of Capital inflows.

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Paper provided by Banco de la Republica de Colombia in its series Borradores de Economia with number 226.

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Handle: RePEc:bdr:borrec:226
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  1. Correia, I. & Rabelo, S. & Naves, J.C., 1994. "Business Cycles in a Small Open Economy," RCER Working Papers 382, University of Rochester - Center for Economic Research (RCER).
  2. Cristina Arellano & Enrique Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," Research Department Publications 4307, .
  3. Enrique G. Mendoza & Katherine A. Smith, 2002. "Margin Calls, Trading Costs, and Asset Prices in Emerging Markets: The Finanical Mechanics of the 'Sudden Stop' Phenomenon," NBER Working Papers 9286, National Bureau of Economic Research, Inc.
  4. Carmen M. Reinhart, 2002. "Default, Currency Crises and Sovereign Credit Ratings," NBER Working Papers 8738, National Bureau of Economic Research, Inc.
  5. Pablo Neumeyer & Fabrizio Perri, 2004. "Business cycles in emerging economies: the role of interest rates," Staff Report 335, Federal Reserve Bank of Minneapolis.
  6. Zhang, Harold H, 1997. " Endogenous Borrowing Constraints with Incomplete Markets," Journal of Finance, American Finance Association, vol. 52(5), pages 2187-2209, December.
  7. Cristina Arellano & Enrique G. Mendoza, 2002. "Credit Frictions and 'Sudden Stops' in Small Open Economies: An Equilibrium Business Cycle Framework for Emerging Markets Crises," NBER Working Papers 8880, National Bureau of Economic Research, Inc.
  8. Franz Hamann, . "Sovereign Risk and Macroeconomic Fluctuations," Borradores de Economia 225, Banco de la Republica de Colombia.
  9. Reisen, Helmut & Von Maltzan, Julia & Larraín, Guillermo, 1998. "Emerging market risk and sovereign credit ratings," Sede de la CEPAL en Santiago (Estudios e Investigaciones) 34380, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL).
  10. 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.
  11. 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.
  12. S. Rao Aiyagari, 1993. "Uninsured idiosyncratic risk and aggregate saving," Working Papers 502, Federal Reserve Bank of Minneapolis.
  13. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
  14. repec:idb:brikps:6499 is not listed on IDEAS
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