Financial Architecture in Emerging Market Economies∗

This paper analyzes the determinants of the composition of sovereign bond, corporate bond and bank financing in a general equilibrium model of the financial sector of an emerging market economy (EME). We model an EME as an economy with a shortage of capital, weak debt enforcement institutions and potential government overborrow-ing, which may expose the country to sovereign default risk. As in Bolton and Freixas (2005) we model banks as having a comparative advantage in restructuring debt of financially distressed firms, but their lending is constrained by capital adequacy requirements. Cor-porate bond financing is a less flexible form of financing but is uncon-strained by any capital adequacy requirements.This framework allow us to identify when it is that it is efficient to create a bond market, as well as the types of loans that are susceptible of being securitized in an EME. ∗The authors have benefit from comments by the attendants of the II workshop of the Latin American Research Network. They also acknowledge the excellent research assistantship work of Milos Bozovic. The usual disclaimer applies