Market Disciplining of the Developing Countries' Sovereign Governments

Abstract:     
In this paper, we contribute to the current literature on market disciplining of the sovereign governments of the developing countries by distinguishing both sides of the market discipline hypothesis by adopting three-stage least square estimation to incorporate the contemporaneous feedback effects between primary structural budget balances and the country’s default risk premiums. We provide empirical evidence of a unidirectional causal relationship between a country’s default-risk premium and primary structural budget balances with the direction flowing from primary structural budget balances to country’s risk premium in 40 developing countries over the period 1975 to 2008. We also employ the Arrelano-Bond dynamic panel generalized methods of moments estimation to control for this joint determination of primary structural budget balances and the country’s default risk premium, and find supportive evidence of undisciplined sovereign governments and of non-linearly behaving well-functioning financial markets in the sample countries.

Number of Pages in PDF File: 39

Keywords: Market Discipline Hypothesis, Structural Budget Balances, Country Default Risk Premium

JEL Classification: C5, G1, G3

Accepted Paper Series