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Board of Governors of the Federal Reserve System (U.S.)
International Finance Discussion Papers
Financial Frictions and Macroeconomic Fluctuations in Emerging Economies
Ozge Akinci
Abstract

Estimated dynamic models of business cycles in emerging markets deliver counterfactual predictions for the country risk premium. In particular, the country interest rate predicted by these models is acyclical or procyclical, whereas it is countercyclical in the data. This paper proposes and estimates a small open economy model of the emerging-market business cycle in which a time-varying country risk premium emerges endogenously. In the proposed model, a firm's borrowing rate adjusts countercyclically as the default threshold of the firm depends on the state of the macroeconomy. I econometrically estimate the proposed model and find that it can account for the volatility and the countercyclicality of country risk premium as well as for other key emerging market business cycle moments. Time varying uncertainty in firm specific productivity contributes to delivering a countercyclical default rate and explains 70 percent of the variances in the trade balance and in the country risk premium. Finally, I find the predicted contribution of nonstationary productivity shocks in explaining output variations falls between the extremely high and extremely low values reported in the literature.


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Ozge Akinci, Financial Frictions and Macroeconomic Fluctuations in Emerging Economies, Board of Governors of the Federal Reserve System (U.S.), International Finance Discussion Papers 1120, 24 Oct 2014.
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Keywords: Financial frictions; country risk premium; international business cycles; Bayesian estimation
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