Computing business cycles in emerging economy models
We show that computing business cycles in emerging economy models using the discrete state space technique may be misleading. We solve the models of sovereign default presented by Aguiar and Gopinath (2006) using interpolation. We find that the simulated behavior of the spread is quite different from the behavior obtained using discrete state space. In fact, some of the results obtained by Aguiar and Gopinath (2006) using discrete state space are reversed when using interpolation. Our analysis thus provides a new set of benchmark results for quantitative models of sovereign default. ; Updated ...
Life cycle patterns and boom-bust dynamics in U.S. housing prices
Home equity did not increase much for households younger than 35 years of age between 1998 and 2007 because the increase in house prices was offset by an equivalent increase in mortgage debt.
International Reserves and Rollover Risk
We study the optimal accumulation of international reserves in a quantitative model of sovereign default with long-term debt and a risk-free asset. Keeping higher levels of reserves provides a hedge against rollover risk, but this is costly because using reserves to pay down debt allows the government to reduce sovereign spreads. Our model, parameterized to mimic salient features of a typical emerging economy, can account for a significant fraction of the holdings of international reserves, and the larger accumulation of both debt and reserves in periods of low spreads and high income. We ...
Recoveries from recessions associated with banking crises : how does this one compare?
Recessions associated with banking crises tend to differ from other recessions in that the weakness of the financial sector, particularly the limited supply of credit, encumbers the subsequent recovery. The recovery from the 2007-09 recession, compared to past recoveries from recessions associated with banking crises, is within the historical range in terms of its level of GDP growth. In terms of unemployment, however, the recovery from the 2007-09 recession is markedly weaker than the historical norm.>
Legal protection to foreign investors
Foreign investment is typically considered an important source of growth for developing countries. This article describes the legal protection granted to foreign investors and its enforcement mechanisms. Governments have signed international investment agreements intended to protect foreign investors from the risk of expropriation and have increasingly chosen to issue sovereign debt in international financial centers, which expose defaulting governments to litigations in foreign national courts. In most cases, governments have complied with unfavorable rulings of international arbitration ...
Quantitative properties of sovereign default models: solution methods matter
We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique ...
Is a new asset bubble emerging in certain markets?
Some economists have argued that recent rallies in certain asset markets ? most notably, commodities and emerging market equities ? represent the emergence of a new bubble fueled by accommodative monetary policy and carry trade activity. There is evidence, though, that the rallies can be explained by strong economic fundamentals in these markets.
Long-duration bonds and sovereign defaults
This paper extends the baseline framework used in recent quantitative studies of sovereign default by assuming that governments can borrow using long-duration bonds. Previous studies have assumed that governments can borrow using bonds that mature after one quarter. Once we assume that the government issues bonds with a duration that is close to the average duration observed in emerging economies, the model is able to generate a substantially higher and more volatile interest rate. This narrows the gap between the predictions of the model and the data, which indicates that the introduction of ...
Europe may provide lessons on preventing mortgage defaults
During the last global recession, house prices fell in some European countries almost as much as in some U.S. states. However, mortgage defaults occurred at a much lower rate in Europe. The authors say the difference might be explained by two regulations that apply in Europe but are used on a limited or much less restrictive basis in the U.S.