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Commodity Prices and Sovereign Default: A New Perspective on The Harberger-Laursen-Metzler Effect

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Listed:
  • Paulina Restrepo-Echavarria

    (Federal Reserve Bank of St Louis)

  • Enrique Mendoza

    (University of Pennsylvania)

  • Franz Hamann

    (Banco de la República)

Abstract

This paper documents the main facts about the relationship between country risk and default episodes in oil producing economies. We find that oil prices are strongly negatively correlated with risk premia. Furthermore, the ability to extract oil, which enhances a country's ability to repay reduces risk premia, while countries with a large stock of oil reserves exhibit higher risk premia. The latter reflects the fact that having a large stock of oil increases a country's outside option, augmenting the probability of default. We develop a small open economy model, where there is a sovereign government who owns a stock of oil and delegates extracting activities to an oil producing company. The sovereign can trade non-state contingent bonds with risk neutral competitive foreign lenders in international financial markets and cannot commit to repaying its debt. We show that the model can rationalize the empirical findings and explore the following questions: How does the introduction of default risk affect the correlation between the trade balance and terms of trade? How does it affect the co-movement between that correlation and the persistence of terms of trade shocks? What happens in the model if we do conditional versus unconditional comparisons to evaluate this relationship?

Suggested Citation

  • Paulina Restrepo-Echavarria & Enrique Mendoza & Franz Hamann, 2016. "Commodity Prices and Sovereign Default: A New Perspective on The Harberger-Laursen-Metzler Effect," 2016 Meeting Papers 806, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:806
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    References listed on IDEAS

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    1. Pesaran, M. Hashem & Smith, Ron, 1995. "Estimating long-run relationships from dynamic heterogeneous panels," Journal of Econometrics, Elsevier, vol. 68(1), pages 79-113, July.
    2. Im, Kyung So & Pesaran, M. Hashem & Shin, Yongcheol, 2003. "Testing for unit roots in heterogeneous panels," Journal of Econometrics, Elsevier, vol. 115(1), pages 53-74, July.
    3. Lane, Philip & Milesi-Ferretti, Gian Maria, "undated". "External Wealth of Nations," Instructional Stata datasets for econometrics extwealth, Boston College Department of Economics.
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    Cited by:

    1. Sadik-Zada, Elkhan Richard & Gatto, Andrea, 2019. "Determinants of the Public Debt and the Role of the Natural Resources: a Cross-Country Analysis," ETA: Economic Theory and Applications 285026, Fondazione Eni Enrico Mattei (FEEM).
    2. Maria A. Arias & Paulina Restrepo-Echavarria, 2016. "Sovereign Default and Economic Performance in Oil-Producing Economies," Economic Synopses, Federal Reserve Bank of St. Louis, issue 20, pages 1-2.

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