TY - JOUR
T1 - Balance sheet effects and the country risk premium
T2 - An empirical investigation
AU - Berganza, Juan Carlos
AU - Chang, Roberto
AU - Herrero, Alicia García
N1 - Funding Information:
Conventional open economy models, and in particular the influential Mundell-Fleming model, imply that a real devaluation switches demand toward domestic production and is expansionary. But recent theories on credit constraints and balance sheet effects have challenged this view. The argument starts with the observation that if a country has a large debt with the rest of the world, and the value of the debt depends on the real exchange rate, a devaluation causes a fall in the country's net worth. In the presence Remark: We thank Raquel Carrasco for valuable suggestions and Lucia Cuadro for excellent research assistance. We also thank Guillermo Le Fort, Klaus Schmidt-Hebbel, Ugo Panizza, Javier Vall4s, an anonymous referee, and participants in seminars at the Kid Institute for World Economics, Banco de Espafia, and the Euro-Latin IADB network on regional integration for comments and suggestions. Much of Chang's work for this project was completed while a visiting scholar at Banco de Espafia, whose hospitalityhe acknowledges with gratitude. He also thanks the National Science Foundation for financial support. Of course, any errors are only ours. Finally, the opinions expressed are those of the authors and do not necessarily reflect those of the Banco de Espafia. Please address correspondence to Alicia Garcia Herrero, Economia y Relaciones Internacionales, Banco de Es-pafia, Alcahl 50, 28014 Madrid, Espafia; e-mail: [email protected]
PY - 2004
Y1 - 2004
N2 - Based on recent theories emphasizing financial imperfections, this paper is an empirical investigation of the link between a country's risk premium and the balance sheet effect of a devaluation. In a panel of emerging economies, balance sheet effects, due to increased external debt service after an unexpected real depreciation, significantly raise the risk premium. This result is robust to various checks and appears driven by those countries with the largest financial imperfections. Also, particularly large real depreciations turn out to be disproportionately important, meaning that balance sheet effects may be strongest at times of economic crisis. JEL no. F34, F41.
AB - Based on recent theories emphasizing financial imperfections, this paper is an empirical investigation of the link between a country's risk premium and the balance sheet effect of a devaluation. In a panel of emerging economies, balance sheet effects, due to increased external debt service after an unexpected real depreciation, significantly raise the risk premium. This result is robust to various checks and appears driven by those countries with the largest financial imperfections. Also, particularly large real depreciations turn out to be disproportionately important, meaning that balance sheet effects may be strongest at times of economic crisis. JEL no. F34, F41.
KW - Balance sheet effects
KW - Devaluation
KW - Liability dollarization
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U2 - 10.1007/BF02659616
DO - 10.1007/BF02659616
M3 - Article
AN - SCOPUS:24144455309
SN - 1610-2878
VL - 140
SP - 592
EP - 612
JO - Review of World Economics
JF - Review of World Economics
IS - 4
ER -