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Sovereign Risk and Macroeconomic Fluctuations

  • Franz Hamann

    ()

This paper investigates the impact of sovereign risk on the stochastic rational expectations equilibrium of a pure exchange small open economy. International borrowing and lending arise from the interaction between a risk averse sovereign representative agent in a small open economy trying to self insure against idiosyncratic shocks and risk neutral international lenders. 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 endogenous rationing by foreign creditors. The model is parameterized and solved numerically. The experiments conducted here generalize the results of Eaton and Gersovitz (1981) into environments with varying degrees of persistence and volatility in the underlying stochastic income process.

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Paper provided by BANCO DE LA REPÚBLICA in its series BORRADORES DE ECONOMIA with number 003520.

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Length: 31
Date of creation: 30 Nov 2002
Date of revision:
Handle: RePEc:col:000094:003520
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  1. Neumeyer, Pablo A. & Perri, Fabrizio, 2005. "Business cycles in emerging economies: the role of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 345-380, March.
  2. Zhang, Harold H, 1997. " Endogenous Borrowing Constraints with Incomplete Markets," Journal of Finance, American Finance Association, vol. 52(5), pages 2187-2209, December.
  3. 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, Inter-American Development Bank, Research Department.
  4. Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995. "Business cycles in a small open economy," European Economic Review, Elsevier, vol. 39(6), pages 1089-1113, June.
  5. Cole, Harold L & Dow, James & English, William B, 1995. "Default, Settlement, and Signalling: Lending Resumption in a Reputational Model of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 365-85, May.
  6. Guillermo Larraín & Helmut Reisen & Julia von Maltzan, 1997. "Emerging Market Risk and Sovereign Credit Ratings," OECD Development Centre Working Papers 124, OECD Publishing.
  7. Reinhart, Carmen, 2002. "Default, currency crises, and sovereign credit ratings," MPRA Paper 13917, University Library of Munich, Germany.
  8. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  9. 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.
  10. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  11. 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.
  12. 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.
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