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 ad-vantage in restructuring debt of financially distressed firms, but their lending is constrained by capital adequacy requirements. Corporate bond financing is a less flexible form of financing but is unconstrained by any capital adequacy requirements. ∗The authors acknowledge the excellent research assistantship work of Milos Bozovic. The usual disclaimer applies