Default Risk and Income Fluctuations in Emerging Economies
- (pp. 690-712)
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.Citation
Arellano, Cristina. 2008. "Default Risk and Income Fluctuations in Emerging Economies." American Economic Review, 98 (3): 690-712. DOI: 10.1257/aer.98.3.690Additional Materials
JEL Classification
- E32 Business Fluctuations; Cycles
- E43 Determination of Interest Rates; Term Structure of Interest Rates
- F34 International Lending and Debt Problems
- O11 Macroeconomic Analyses of Economic Development
- O19 International Linkages to Development; Role of International Organizations