Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets

Gabriel Cuadra and Horacio Sapriza

No 2006-01, Working Papers from Banco de México

Abstract: Emerging economies tend to experience larger fluctuations in their terms of trade, countercyclical interest rates and more default episodes than developed countries. These structural features might suggest a relevant role for world prices in driving country spreads. This paper studies the role of terms of trade shocks in inducing output fluctuations and countercyclical spreads using a stochastic dynamic general equilibrium model of a small open economy. The model predicts that default incentives and default premia are higher in recessions, as observed in the data. In a quantitative exercise, the model matches various features of emerging economies and can account for the dynamics of default episodes in these markets.

JEL-codes: F34 F41 (search for similar items in EconPapers)
Date: 2006-02
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Citations: View citations in EconPapers (28)

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