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Commodity price risk management and fiscal policy in a sovereign default model

Bernabe Lopez-Martin (), Julio Leal Ordóñez and Andre Martinez Fritscher

No 620, BIS Working Papers from Bank for International Settlements

Abstract: Commodity prices are an important driver of fiscal policy and the business cycle in many developing and emerging market economies. We analyze a dynamic stochastic small-open-economy model of sovereign default, featuring endogenous fiscal policy and stochastic commodity revenues. The model accounts for a positive correlation of commodity revenues with government expenditures and a negative correlation with tax rates. We quantitatively document the extent to which the utilization of different financial hedging instruments by the government contributes to lowering the volatility of different macroeconomic variables and their correlation with commodity revenues. An event analysis illustrates how financial hedging instruments moderate fiscal adjustment in response to significant falls in the price of commodities. We evaluate the conditional and unconditional welfare gains for the representative household, generated by financial derivatives and commodity-indexed bonds.

Keywords: commodity revenues; hedging; indexed bonds; fiscal policy; sovereign default (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-mac and nep-rmg
Date: 2017-03
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Working Paper: Commodity Price Risk Management and Fiscal Policy in a Sovereign Default Model (2017) Downloads
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