A General Equilibrium Model of Sovereign Default and Business Cycles

Zhanwei Yue and Enrique Mendoza

No 2011/166, IMF Working Papers from International Monetary Fund

Abstract: Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-noc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios, and key business cycle moments.

Keywords: WP; debt ratio; working capital; Sovereign default; business cycles; country risk; external debt; default event; default frequency; default probability; credit market; transmission mechanism; result default; default incentive; country default; sensitivity analysis; utility function; default punishment; Total factor productivity; Labor supply; Debt default; Eastern Europe; Western Hemisphere; Western Europe; Africa (search for similar items in EconPapers)
Pages: 55
Date: 2011-07-01
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Citations: View citations in EconPapers (33)

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Related works:
Journal Article: A General Equilibrium Model of Sovereign Default and Business Cycles (2012)
Working Paper: A General Equilibrium Model of Sovereign Default and Business Cycles (2011)
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