Lizarazo, Sandra (2011): Default risk and risk averse international investors.
Download (300kB) | 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 an emerging economy, the present model explains a larger proportion and volatility of the spread between sovereign bonds and riskless assets than the standard model with risk neutral investors. The paper shows that if investors have DARA preferences, then the emerging economy's default risk, capital flows, and bond prices are a function not only of the fundamentals of the economy but also of the level of financial wealth and risk aversion of 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 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:||02 Mar 2012 20:38|
|Last Modified:||07 Feb 2016 15:05|
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.
Arellano, C., and Ramanarayan, A. (2008). Default and Maturity Structure in Sovereign Bonds. Staff Report 410, Federal Reserve Bank of Minneapolis.
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.
Benjamin, D., and Wright, M.,(2008). Recovery before Redemption? A Theory of Delays in Sovereign Debt Renegotiations. Working Paper.
Broner, F., Gelos, G., and Reinhart, C., (2006). When in Peril, Retrench: Testing the Portfolio Channel of Contagion. Journal of International Economics} 69.
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.
Cuadra, G., and Sapriza, H., (2008). Sovereign default, interest rates and political uncertainty in emerging markets. Journal of International Economics}, 76, 78-88.
Cunningham, A., Dixon, L., and Hayes, S., (2001). Analyzing Yield Spreads on Emerging Market Sovereign Bonds. Financial Stability Review, December 2001.
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).
Gelos, G., Sahay R., and Sandleris, G., (2004). Sovereign Borrowing in Developing Countries: What Determines Market Access?. Working Paper, 04/221, IMF, 2004.
Gonzalez, M., and Levy, E., (2006). Global factors and Emerging Markets Spreads. Inter-American Development Bank Working Paper, 552.
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., and Martinez, L., (2009). Long Duration Bonds and Sovereign Defaults. Journal of International Economics, 79, 117-125.
Hatchondo, J., Martinez, L. and Sapriza H., (2008). Heterogeneous Borrowers in Quantitative Models of Sovereign Default. International Economic Review (forthcoming), (2008).
Hau, H. and Rey, H., (2008). Global Portfolio Rebalancing Under the Microscope. NBER Working Paper, 14165.
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.
Klingen, C., Weder, B., and Zettelmeyer, J.,(2004). How Private Creditors Fared in Emerging Debt Markets, 1970-2000. IMF Working Paper, WP/04/13.
Lizarazo, S., (2010). Contagion of Financial Crises in Sovereign Debt Markets. Working Paper ITAM.
Longstaff, F., Pan, J., Pedersen L., and Singleton, K., (2008). How Sovereign is Sovereign Credit Risk. Working Paper.
Mendoza, E., and Yue, V., (2011). A General Equilibrium Model of Sovereign Default and Business Cycles. NBER Working Papers, 17151.
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.
Reinhart, C., Rogoff, K., and Savastano, M., (2003). Debt Intolerance. NBER Working Paper 9908, August 2003.
Remolona, E., Scatigna, M., and Wu, E., (2007). Interpreting Sovereign Spreads. BIS Quarterly Review, March.
Sosa-Padilla, C., (2011). Sovereign Defaults and Banking Crises. Working paper University of Maryland.
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.
Available Versions of this Item
Default Risk and Risk Averse International Investors. (deposited 20 Feb 2010 16:45)
- Default risk and risk averse international investors. (deposited 02 Mar 2012 20:38) [Currently Displayed]