A Solution to the Disconnect between Country Risk and Business Cycle Theories / Enrique G. Mendoza, Vivian Z. Yue.

Format:

Book

Author/Creator:

Mendoza, Enrique G.

Contributor:

National Bureau of Economic Research.

Yue, Vivian Z.

Series:

Working Paper Series (National Bureau of Economic Research) no. w13861.

NBER working paper series no. w13861

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2008.

Summary:

We propose a model that solves the crucial disconnect between business cycle models that treat default risk as an exogenous interest rate on working capital, and sovereign default models that treat output fluctuations as an exogenous process with ad-hoc default costs. The model explains observed output dynamics around defaults, countercyclical spreads, high debt ratios, and key business cycle moments. Three features of the model are central for these results: working capital loans pay for imported inputs; default triggers an efficiency loss as imported inputs are replaced by imperfect domestic substitutes; and default on public and private foreign obligations occurs simultaneously.

Notes:

Print version record

March 2008.