Sovereign Risk, Currency Risk, and Corporate Balance Sheets
68 Pages Posted: 30 Sep 2016
Date Written: September 2016
We construct a new dataset of 14 emerging markets and show that sovereigns increasingly borrow from foreigners in local currency but the private sector continues to borrow in foreign currency. We show that a higher reliance on foreign currency corporate financing is associated with more sovereign default risk. We introduce local currency sovereign debt and private currency mismatch into a standard sovereign debt model to examine how the currency composition of corporate borrowing affects the sovereign’s incentive to inflate or default. A calibration of the model generates the empirical patterns of currency and sovereign credit risk over the last decade.
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