ESSAYS IN INTERNATIONAL AND FINANCIAL ECONOMICS

This dissertation is a collection of three essays in international and financial economics. In these essays, I focus on government debt and firm financing decisions over the business cycle. In the first essay, I study the role of income inequality in government’s borrowing and default decisions. To explore the relationship between default risk and income inequality, I extend the standard endogenous default model to allow for heterogeneous agents. The main finding of this paper is that inequality shocks can increase the default risk significantly. The model can also generate high consumption volatility of poor households relative to rich households, consistent with the data. I extend the model by introducing progressive income taxes and show that as the progressivity of the tax increases, the probability of default decreases. In the second essay, I address how the financing of working capital plays a role in the default risk and the business cycle characteristics observed in emerging market economies. I propose a general equilibrium model with endogenous sovereign default risk and working capital conditions and study the role of labor markets in generating the drops in output observed in defaults. I find that the working capital condition increases the default risk through a feedback loop. I show that this model is able to match the countercyclical interest rates, high volatility of consumption relative to output and countercyclical trade balance observed in Argentina. The third essay analyzes the role of binding financing constraints on manufacturing firms’ investment decisions in the U.S., using the Great Recession period as a natural case study. The main finding of this paper is that firms that do not borrow from public bond markets experienced binding liquidity constraints on their R&D investments during the recession. The paper also compares the evidence on financial constraints in R&D investments to the evidence about capital and inventory investments. Firms without bond ratings show the highest liquidity sensitivity for inventory investments, and investment-liquidity sensitivity is greater for capital than it is for R&D investments