Sovereign risk and macroeconomic fluctuations

This dissertation investigates the properties of macroeconomic fluctuations in a small open economy under the presence of sovereign default risk. It also studies its potential impact on monetary policy. The first chapter briefly reviews the literature. The second presents a simple model of sovereign risk that explains how default can be triggered by shocks that drive normal business cycles, albeit in the context of an endowment economy. The model is calibrated to the Argentine economy. It is able to reproduce counter-cyclical country risk spreads, large capital outflows during Sudden Stops, and default. Using numerical methods, this paper also proposes an algorithm for the solution of this family of models that allows to generalize the results of Eaton and Gersovitz (1981) into environments with varying degrees of persistence and volatility in the underlying stochastic income process.; In the third chapter the assumption of an endowment economy is relaxed. Once again, the model is calibrated to the Argentine economy. It reproduces the main macroeconomic volatilities and correlations as consumption, investment and output, but fails to reproduce those of trade balance, current account and interest rates. Further research is needed in this direction.; The fourth chapter focuses on monetary policy in small open economies. It presents a dynamic stochastic general equilibrium model of inflation targeting in a small open economy. The model is calibrated to the Colombian economy to study the response of some macroeconomic variables to different types of shocks that are relevant for emerging economies. The sensitivity of those responses to some key parameters is also analyzed. Furthermore, using simulated data from the model, the ability of the model to capture the spectra, the phase and the coherence of observed output and inflation are studied.