Default Risk and Income Fluctuations in Emerging Economies
American Economic Review · 2008 · Volume 98 · Issue 3
Abstract
Recent sovereign defaults are accompanied by interest rate spikes and deep recessions. This paper develops a small open economy model to study default risk and its interaction with output and foreign debt. Default probabilities and interest rates depend on incentives for repayment. Default is more likely in recessions because this is when it is more costly for a risk averse borrower to repay noncontingent debt. The model closely matches business cycles in Argentina predicting high volatility of interest rates, higher volatility of consumption relative to output, and negative correlations of output with interest rates and the trade balance.
Keywords
Business Fluctuations, Cycles, Determination of Interest Rates, Term Structure of Interest Rates, International Lending and Debt Problems, Macroeconomic Analyses of Economic Development, International Linkages to Development, Role of International Organizations
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