Essays on international macroeconomicsdebt in emerging and developed economies

Resumo

Countries across the world borrow and lend in the international debt market, which is characterised by the presence of default risk. In my thesis, I present models of debt with endogenous default and discuss macroeconomic outcomes in emerging and developed economies. In the first chapter, I develop a simple model of borrowing and lending within the monetary union. I characterize the default decision of the borrowing country and explore the impact that the monetary union has on the amount of borrowing, the rate of interest and the default probability. The key assumptions of the modelling strategy are that in the monetary union, the lender is risk averse with monopoly power rather than risk neutral with perfect competition. I find that the borrowing member country of the monetary union borrows more at cheaper cost vis-à-vis a standalone borrowing country. Further, I find that forming a monetary union with high initial income disparity between the member countries leads to more and cheaper borrowing and higher default probabilities. This chapter considers the debt market of European Economic Monetary Union (EMU). In 1999, formation of EMU led to the adoption of the Euro as a common currency among member countries and to their surrendering of national monetary policy in favour of the European Central Bank. In the second chapter, I present a model that uses a pricing kernel to evaluate risk and return in financial markets of a lending country while embedding it in a model of sovereign default of a borrowing country. Thus, I bring together two separate strands of literature and present a holistic model of international finance, which evaluates how pricing of risk affects the price of debt, spreads and behaviour of the borrowing country, i.e., its ability to borrow and smooth consumption. This chapter draws motivation from real world events. Domestic economy of the emerging markets and international sovereign debt market, such as those of Latin America and Asia, are affected by changes in the U.S. monetary policy. In 1994, the U.S. monetary policy was tightened that resulted in widening of sovereign spreads. In 1998, an opposite effect took place after loosening of the monetary policy. A rise in U.S. rates tends to increase the debt-service burden of the borrowing country, which reduces their ability to repay. A change in interest rate influences the cost of borrowing for the investors. This in turn affects the borrowing side of the economy.