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Author:Arellano, Cristina 

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Appendix for Financial Frictions and Fluctuations in Volatility

This appendix contains five sections. Section 1 provides details for the comparative statics exercise performed in the simple example. Section 2 discusses extending the model to allow firms to default on the wages for managers. Section 3 describes the firm-level and aggregate data. Section 4 contains the details of the computational algorithm. Finally, Section 5 reports the results for our model with a lower labor elasticity.
Staff Report , Paper 538

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Financial frictions and fluctuations in volatility

During the recent U.S. financial crisis, the large decline in economic activity and credit was accompanied by a large increase in the dispersion of growth rates across firms. However, even though aggregate labor and output fell sharply during this period, labor productivity did not. These features motivate us to build a model in which increased volatility at the firm level generates a downturn but has little effect on labor productivity. In the model, hiring inputs is risky because financial frictions limit firms' ability to insure against shocks that occur between the time of production and ...
Staff Report , Paper 466

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External and Public Debt Crises

The recent debt crises in Europe and the U.S. states feature similar sharp increases in spreads on government debt but also show important differences. In Europe, the crisis occurred at high government indebtedness levels and had spillovers to the private sector. In the United States, state government indebtedness was low, and the crisis had no spillovers to the private sector. We show theoretically and empirically that these different debt experiences result from the interplay between differences in the ability of governments to interfere in private external debt contracts and differences in ...
Staff Report , Paper 515

Discussion Paper
Chronic sovereign debt crises in the Eurozone, 2010-2012

Two years after the rescue package for Greece provided by the European Union and the International Monetary Fund in May 2010, sovereign debt crises continue to threaten a growing number of countries in the eurozone. We develop a theory for analyzing these crises based on the research of Cole and Kehoe (1996, 2000) and Conesa and Kehoe (2012). In this theory, the need to frequently sell large quantities of bonds leaves a country vulnerable to sovereign debt crisis. This vulnerability provides a strong incentive to the country?s government to run surpluses to pay down its debt to a level where ...
Economic Policy Paper , Paper 12-4

Working Paper
External and Public Debt Crises

The recent debt crises in Europe and the U.S. states feature similar sharp increases in spreads on government debt but also show important differences. In Europe, the crisis occurred at high government indebtedness levels and had spillovers to the private sector. In the United States, state government indebtedness was low, and the crisis had no spillovers to the private sector. We show theoretically and empirically that these different debt experiences result from the interplay between differences in the ability of governments to interfere in private external debt contracts and differences in ...
Working Paper Series , Paper WP-2015-5

Working Paper
Dollarization and financial integration

How does a country?s choice of exchange rate regime impact its ability to borrow from abroad? We build a small open economy model in which the government can potentially respond to shocks via domestic monetary policy and by international borrowing. We assume that debt repayment must be incentive compatible when the default punishment is equivalent to permanent exclusion from debt markets. We compare a floating regime to full dollarization. We find that dollarization is potentially beneficial, even though it means the loss of the monetary instrument, precisely because this loss can strengthen ...
International Finance Discussion Papers , Paper 890

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Sovereign Risk Contagion

We develop a theory of sovereign risk contagion based on financial links. In our multi-country model, sovereign bond spreads comove because default in one country can trigger default in other countries. Countries are linked because they borrow, default, and renegotiate with common lenders, and the bond price and recovery schedules for each country depend on the choices of other countries. A foreign default increases the lenders' pricing kernel, which makes home borrowing more expensive and can induce a home default. Countries also default together because by doing so they can renegotiate the ...
Staff Report , Paper 559

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Default and the maturity structure in sovereign bonds

This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. In the data, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large long-term loans are not available because the borrower cannot commit to save in the near future towards ...
Staff Report , Paper 410

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Partial Default

In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the ...
Staff Report , Paper 589

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Sovereign risk and firm heterogeneity

This paper studies the recessionary effects of sovereign default risk using firm-level data and a model of sovereign debt with firm heterogeneity. Our environment features a two-way feedback loop. Low output decreases the tax revenues of the government and raises the risk that it will default on its debt. The associated increase in sovereign interest rate spreads, in turn, raises the interest rates paid by firms, which further depresses their production. Importantly, these effects are not homogeneous across firms, as interest rate hikes have more severe consequences for firms that are in need ...
Staff Report , Paper 547

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