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A General Equilibrium Model of Sovereign Default and Business Cycles

  • Enrique G. Mendoza
  • Vivian Z. Yue

Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-hoc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around defaults, countercyclical spreads, high debt ratios, and key business cycle moments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17151.

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Date of creation: Jun 2011
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Publication status: published as Enrique G. Mendoza & Vivian Z. Yue, 2012. "A General Equilibrium Model of Sovereign Default and Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 889-946.
Handle: RePEc:nbr:nberwo:17151
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