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Debt denomination and default risk in emerging markets

Gümüş, İnci (2013) Debt denomination and default risk in emerging markets. Macroeconomic Dynamics, 17 (5). pp. 1070-1095. ISSN 1365-1005 (Print) 1469-8056 (Online)

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Official URL: http://dx.doi.org/10.1017/S1365100512000077

Abstract

This paper develops a two-sector small open economy model to analyze the effects of the currency denomination of debt on default risk and interest rates in emerging market economies. Default risk is determined endogenously and depends on the incentives for repayment. The economy can borrow using tradable-denominated nonindexed bonds or bonds whose return is indexed to the domestic price index, which are used as proxies for foreign currency and domestic currency debt, respectively. The model predicts that foreign currency debt leads to lower default risk for high output levels and domestic currency debt reduces the default risk for low output levels. Although the effect of debt denomination on default risk changes with the output level, the default rate of the economy and average interest rates decline as domestic currency borrowing increases. In addition, domestic currency borrowing is found to reduce the countercyclicality of interest rates and the trade balance.

Item Type:Article
Uncontrolled Keywords:Sovereign Default; Debt Denomination; Interest Rates; Real Exchange Rates
Subjects:H Social Sciences > HB Economic Theory
ID Code:22022
Deposited By:İnci Gümüş
Deposited On:12 Nov 2013 17:31
Last Modified:12 Nov 2013 17:31

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