Lizarazo, Sandra (2010): Default Risk and Risk Averse International Investors.
Download (330kB) | Preview
This paper develops a model of debt and default for small open economies that interact with risk averse international investors. The model developed here extends the recent work on the analysis of endogenous default risk to the case in which international investors are risk averse agents with decreasing absolute risk aversion (DARA). By incorporating risk averse investors who trade with a single emerging economy, the present model offers two main improvements over the standard case of risk neutral investors: i.) the model exhibits a better fit of debt-to-output ratio and ii.) the model explains a larger proportion and volatility of the spread between sovereign bonds and riskless assets. The paper shows that if investors have DARA preferences, then the emerging economy's default risk, capital flows, bond prices and consumption are a function not only of the fundamentals of the economy---as in the case of risk neutral investors---but also of the level of financial wealth and risk aversion of the international investors. In particular, as investors become wealthier or less risk averse, the emerging economy becomes less credit constrained. As a result, the emerging economy's default risk is lower, and its bond prices and capital inflows are higher. Additionally, with risk averse investors, the risk premium in the asset prices of the sovereign countries can be decomposed into two components: a base premium that compensates the investors for the probability of default (as in the risk neutral base) and an ``excess'' premium that compensates them for taking the risk of default.
|Item Type:||MPRA Paper|
|Original Title:||Default Risk and Risk Averse International Investors|
|English Title:||Default Risk and Risk Averse International Investors|
|Keywords:||default, sovereign debt, international investors, risk premium, sovereign spreads|
|Subjects:||F - International Economics > F3 - International Finance > F34 - International Lending and Debt Problems
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
|Depositing User:||Sandra Lizarazo|
|Date Deposited:||20. Feb 2010 16:45|
|Last Modified:||12. Feb 2013 12:54|
Aiyagari, R., (1994).Uninsured Idiosyncratic Risk and Aggregate Saving.Quarterly Journal Of Economics 109(3), 600-684, 1994.
Aguiar, M., and Gopinath, G., (2006). Defaultable Debt, Interest Rates and the Current Account. Journal of International Economics 69, 64-83, 2006.
Arellano, C., (2008). Default Risk and Income Fluctuations in Emerging Economies. American Economic Review 98, 670-712, 2008.
Arora, V., and Cerisola, M., (2001). How Does US Monetary Policy Influence Sovereign Spreads in Emerging Markets?. IMF Staff Papers Vol 48, No 3, International Monetary Fund.
Bai, Y., and Zhang, J.,(2006). Financial Integration and International Risk Sharing. Working Paper Michigan University, 2006.
Baig, T., and Goldfajn, I.,(1998). Financial Market Contagion in the Asian Crisis. IMF Working Paper WP/98/155, November 1998.
Baig, T., and Goldfajn, I.,(2000). The Russian default and the Contagion to Brazil. IMF Working Paper WP/00/160, October 2000.
Bekaert, G., Harvey, C., and Lumsdaine, R., (2002). The dynamics of emerging market equity flows. Journal of International Money and Finance 21(3), 295-350, 2002.
Broner, F., Lorenzoni, G., and Schmulker, S., (2005). Why do emerging economies borrow short term?. Working Paper MIT, 2005.
Cantor, R., and Packer, F, (1996). Determinants and Impact of Sovereign Credit Ratings. Economic Policy Review October, 1996. Federal Reserve Bank of New York.
Chatterjee, S., Corbae, D., Nakajima, M., and Rios-Rull, J., (2007). A Quantitative Theory of Unsecured Consumer Credit with Risk of Default. Econometrica 75, 1525-1589, 2007.
Cline, W., and Barnes, K., (1997). Spreads and Risk in Emerging Market Lending. Working Paper 97-1, December 1997. Institute of International Finance.
Cuadra, G., and Sapriza, H., (2008). Sovereign default, interest rates and political uncertainty in emerging markets. Journal of International Economics , 2008 (forthcoming).
Cunningham, A., Dixon, L., and Hayes, S., (2001). Analyzing Yield Spreads on Emerging Market Sovereign Bonds. Financial Stability Review, December 2001.
Eaton, J., and Gersovitz, M.,(1981). Debt with Potential Repudiation: Theoretical and Empirical Analysis. Review of Economic Studies Vol XLVIII, 289-309.
Eichengreen, B., and Mody, A., (2002). Interest Rates in the North and Capital Flows to the South: Is There a Missing Link? International Finance Vol 1, Issue 1, 35-57, 2002.
Ferruci, G., Herzberg, V., Soussa, F., Taylor, A., (2004). Understanding Capital Flows to Emerging Market Economies. Financial Stability Review}: June 2004.
FitzGerald, V., and Krolzig, D., (2003). Modeling the Demand for Emerging Market Assets. Working Paper, April (2003).
Forbes, K., and Rigobon, R., (1999). No contagion only Interdependence: Measuring Stock Market Comovements NBER Working Paper 7267, July 1999.
Gelos, G., Sahay R., and Sandleris, G., (2004). Sovereign Borrowing in Developing Countries: What Determines Market Access?. Working Paper, 04/221, IMF, 2004.
Goldberg, L., (2006). The International Exposure of US Banks: Europe and Latin American Compare . NBER Working Paper, 11365, May 2005.
Hatchondo, J., and Martinez, L., (2006). Computing Business Cycles in Emerging Economy Models. The Federal Reserve Bank of Richmond Working Paper, 06-11, (2006).
Hatchondo, J., Martinez, L. and Sapriza H., (2008). Heterogeneous Borrowers in Quantitative Models of Sovereign Default. International Economic Review (forthcoming), (2008).
Hernandez, L., Mellado, P., and Valdes, R., (2001). Determinants of Private capital flows in the 1970s and 1990s: Is there evidence of Contagion?. IMF Working Paper WP/01/64, May 2001.
Hernandez, L., and Valdes, R., (2001). What drives Contagion: Trade, Neighborhood, or Financial links IMF Working Paper WP/01/29, March 2001.
Jostova, G., (2006). Predictability in Emerging Sovereign Debt Markets. Journal of Business vol. 79, no. 2.
Kamin, S. and von Kleist, K., (1999). The Evolution and Determinants of Emerging Market Credit Spreads in the 1990s. Working Paper (1999). Bank for International Settlements and Federal Reserve Board.
Kaminsky, G., and Reinhart, C., (1998). Financial Crises in Asia and Latin America: Then and Now. American Economic Review Vol 88, Issue 2, Papers and Proceedings of the Hundred and Tenth Annual Meeting of the American Economic Association, May 1998, 444-448.
Kaminsky, G., and Reinhart, C., (2000). On crises contagion and confusion. Journal of International Economics} 51(1), 145-168, 2000.
Kamisnky, G., Lyons, R., and Schmukler, S., (2001). Mutual Fund Investment In emerging Markets: An Overview. The World Bank Economic Review, Vol 15, No 2 315-340, 2001.
Kletzer, K. and Wright, B.,(2000). Sovereign Debt as Intertemporal Barter. American Economic Review 90(3), 621-639, 2000.
Lizarazo, S., (2009). Contagion of Financial Crises in Sovereign Debt Markets. Working Paper ITAM, January 2009.
Mody, A., and Taylor, M., (2003). The High Yield Spread as a Predictor of Real Economic Activity: Evidence of a Financial Accelerator for the United States. IMF Staff papers 50(3), 373-402, 2003.
Neumeyer, P., and Perri, F., (2005). Business Cycles in Emerging Economies: The Role of Interest Rates. Journal of Monetary Economics 52/2, 345-380, March 2005.
Paasche, B., and Zin, S., (2001). Competition and Intervention in Sovereign Debt Markets. NBER Working Paper 8679, December 2001.
Reinhart, C., (2002). Default, Currency Crises and Sovereign Credit Ratings. NBER Working Paper 8738, January 2002.
Reinhart, C., Rogoff, K., and Savastano, M., (2003). Debt Intolerance. NBER Working Paper 9908, August 2003.
Uribe, M., and Yue, V., (2006). Country Spreads and Emerging Countries: Who Drives Whom?. Journal of International Economics 69, 6-36, 2006.
Valdes, R., (1996). Emerging Markets Contagion: Evidence and theory. Banco Central de Chile. Documentos de Trabajo del Banco Central.
Van Rijckeghem, C. and Weder, B., (2001). Sources of Contagion: Finance or Trade?. Journal of International Economics 54(2), 293-308, 2001.
Warther, V., (1995). Aggregate Mutual Funds Flows and Security Returns. Journal of Financial Economics, 39, 209-235.
Westphalen, M., (2001). The Determinants of Sovereign Bond Spreads Changes. Working Paper, Universite de Lausanne, and Fame, November (2001).
Wright, M., (2002). Reputations and Sovereign Debt. Working Paper, September 2002.
Yue, V., (2006). Sovereign Default and Debt Renegotiation. Working Paper, New York University, November 2006.
Available Versions of this Item
- Default Risk and Risk Averse International Investors. (deposited 20. Feb 2010 16:45) [Currently Displayed]