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Pricing sovereign debt in resource rich economies

Thomas McGregor ()

No 194, OxCarre Working Papers from Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford

Abstract: This paper investigates the link between commodity price movements and risk premiums in resource-dependent,developing economies. I develop a stochastic general equilibrium model of a small open economy that receives a stream of resourc erevenues.The government sells bonds to foreign investors which it can renege on in the future, at some cost, whilst international investors form expectations on the likelihood of sovereign default. This delivers an endogenous risk premium which is inversely related to the price of oil.The model is able to explain a large proportion of the business cycle fl uctuations in interest-rate spreads in resource dependent developing economies. I then ask how specific structural features of developing economies affect the relationship between commodity prices and the optimal price of sovereig ndebt, including:a higher dependence on natural resource revenues, impatient consumers and governments,a higher degree of risk-aversion, and a lower ability to substitute consumption inter-temporally. Including them in the model significantly improves the ability of the model to explain the key macroeconomic co-movements in a resource rich, developing economy context. Model simulations reveal an interesting policy insight. An endogenous risk premium that is driven by falling oil prices, provides an additional rationale for a volatility fund in which liquidity buffers are accumulated to manage debt repayments. These buffers should be larger the stronger the link between oil prices and the domestic economy is, the more impatient policymakers are and the more willing they are to substitute current for future consumption.

Keywords: Pricing sovereign debt; default; natural resources; BBC; volatility fund (search for similar items in EconPapers)
JEL-codes: E13 E32 E44 F34 O11 O13 O16 H63 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-ene, nep-mac and nep-opm
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:oxf:oxcrwp:194

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