Sovereign Defaults, External Debt, and Real Exchange Rate Dynamics
IMF Working Papers, February 25, 2016
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- Sovereign Defaults, External Debt, and Real Exchange Rate Dynamics
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Bibliographic details
- Authors: Tamon Asonuma
- Published: February 25, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475597738.001
Summary findings
- Emerging countries experience real exchange rate depreciations around defaults.
- The paper examines this observed pattern empirically and through a dynamic stochastic general equilibrium model.
- The theoretical model explicitly incorporates bond issuances in local and foreign currencies, and endogenous determination of real exchange rate and default risk.
- Quantitative analysis replicates the link between real exchange rate depreciation and default probability around defaults and moments of the real exchange rate that match the data.
- Prior to default, interactions of real exchange rate depreciation, originated from a sequence of low tradable goods shocks with the sovereign’s large share of foreign currency debt, trigger defaults.
- In post-default periods, the resulting output costs and loss of market access due to default lead to further real exchange rate depreciation.
Model and mechanisms analyzed
- Endogenous determination of:
- Real exchange rate.
- Default risk.
- Explicit modeling of bond issuances in:
- Local currency.
- Foreign currency.
- Key causal mechanism:
- Sequence of low tradable goods shocks → real exchange rate depreciation.
- Large share of foreign currency debt amplifies default probability.
- Default produces output costs and loss of market access → additional real exchange rate depreciation in post-default periods.
Quantitative results and empirical replication
- The model quantitatively replicates:
- The link between real exchange rate depreciation and default probability around defaults.
- Moments of the real exchange rate consistent with the data.
Subject areas and keywords (as provided)
- Subject: Consumption, Currencies, Depreciation, External debt, Foreign currency debt, Foreign exchange, Money, National accounts, Real exchange rates, Yield curve
- Keywords: Bond Spreads, business cycle, Consumption, Currencies, Currency Composition of Debt, default choice, default period, default probability, Depreciation, exchange rate, exchange rate depreciation, External Debt, foreign currency, Foreign currency debt, GDP ratio, Global, meaning appreciation, Real Exchange Rate, Real exchange rates, Sovereign Defaults, tradable goods, WP