Essays in sovereign default and emerging economies

We study sovereign debt default in small open economies and the relation linking sovereign bond spreads, business cycles, and exchange rate policy in emerging economies. In the second chapter, Sovereign Default and Debt Renegotiation, we develop a small open economy model to study sovereign default and debt renegotiation within a dynamic borrowing framework. A country\u27s future borrowing and default decisions affect the determination of debt recovery rates in a Nash bargaining game; whereas the endogenous debt recovery rates, in turn, influence the country\u27s ex ante incentive to default. Sovereign bonds are priced to compensate creditors for the risks of default and debt restructuring in equilibrium. We find that both equilibrium debt recovery rates and sovereign bond prices decrease with the level of debt. We also show that the model quantitatively accounts for the volatile and countercyclical bond spreads, countercyclical current account and other empirical regularities of the Argentine economy. In the third chapter, Country Spreads and Emerging Countries: Who Drives Whom?, we disentangle the link among the world interest rate, country spreads, and emerging-market fundamentals, using a methodology that combines empirical and theoretical models. We find that US interest rate shocks explain about 20 percent of movements in aggregate activity in emerging economies; whereas country spread shocks explain about 12 percent of business cycles in emerging economies. We also show that US-interest-rate shocks affect domestic variables mostly through their effects on country spreads. Furthermore, the feedback from emerging-market fundamentals to country spreads significantly exacerbates business-cycle fluctuations. In the fourth chapter, Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries, we investigate the impacts of exchange rate policy on sovereign bond spreads using data on bonds issued by 51 developing countries between 1990 and 2001. We find that real exchange rate overvaluation significantly increases sovereign bond issue probability and raises bond spreads. We also show that spreads and the likelihood of issuing bonds depend on the exchange rate regime. Particularly, exchange rate misalignment under a hard peg significantly increases bond spreads. Moreover, in time of debt crises, exchange rate policy also greatly affects the sovereign bond market, especially through exchange rate overvaluation