Sovereign Defaults, External Debt and Real Exchange Rate Dynamics
42 Pages Posted: 27 Mar 2014 Last revised: 27 Aug 2014
Date Written: March 23, 2014
Emerging countries experience real exchange rate depreciations around defaults. In this paper, we examine this observed pattern empirically and through the lens of 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. Our quantitative analysis, using the case of Argentina's default in 2001, 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.
Keywords: Sovereign defaults; External debt; Real exchange rate; Currency composition
JEL Classification: E43; F32; F34; G12
Suggested Citation: Suggested Citation