Gonzalez-Aguado, Eugenia (2022) Interest Rate Shocks and the Composition of Sovereign Debt. TSE Working Paper, n. 22-1379, Toulouse

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There has been a growing concern about the vulnerability of emerging countries to fluc-tuations in international interest rates. Empirical evidence shows that these countries suffer significant output drops when developed countries raise their interest rates. In this paper, I document that an important determinant of the magnitude of this effect is the ability of coun-tries to issue sovereign debt domestically, rather than to external creditors. Moreover, I find that the level of financial development of domestic markets is positively related to the share of total public debt that is domestically held. I build a model that integrates a domestic banking sector into a sovereign default model where governments can issue domestic and external debt and decide whether to default on debt selectively. Due to financial frictions, issuing domestic debt crowds out investment in capital. As financial markets develop, crowding-out costs decrease, and banks demand lower interest rates on domestic bonds. Both effects reduce the relative cost to the government of borrowing domestically, leading to a higher share of domestic debt. The results of the quantitative solution of the model are consistent with the patterns of vulnerabil-ity to world interest rates and sovereign debt composition observed in the data. I show that financial development, through a less costly access to domestic debt, decreases the vulnerability of emerging economies to external shocks.

Item Type: Monograph (Working Paper)
Language: English
Date: November 2022
Place of Publication: Toulouse
Uncontrolled Keywords: Sovereign debt, Interest rates, International spillovers, Financial development
JEL Classification: E44 - Financial Markets and the Macroeconomy
F34 - International Lending and Debt Problems
F42 - International Policy Coordination and Transmission
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 15 Nov 2022 14:02
Last Modified: 25 Nov 2022 10:43
OAI Identifier: oai:tse-fr.eu:127468
URI: https://publications.ut-capitole.fr/id/eprint/46413
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