| Business cycles in emerging market economies are systematically associated with countercyclical changes in their country spreads: namely, in bad times, countries borrow less at higher spread and default more frequently. To examine this prominent aspect of emerging countries, this dissertation studies a small open economy model of sovereign default in a dynamic stochastic general equilibrium environment. In this model, defaults arise not only from bad output shocks, but also from coordination failures among international lenders. When a country's debt lies within a certain output-contigent interval, a loss of confidence in the country's repayment ability leads to a debt roll-over failure, triggering a self-fulfilling default. The default probability explicitly depends on the strategic incentives and the beliefs of market participants. In a quantitative analysis of Argentina, the model matches several features of the economy: First, the model successfully generates the high volatility of consumption relative to output as well as the high volatility of net exports in emerging economy data. Second, defaults occur not only in bad times, but also in good times. This implies a much weaker relationship between outputs and default events than that predicted by previous studies and is perfectly consistent with recent historical findings (Tomz and Wright (2006)). The later part of this dissertation quantitatively examines the effectiveness of long-term bonds in preventing the liquidity crises. |
