This thesis studies a model presented by Neumeyer & Perri (2005), which aims to explain the strong countercyclicality of interest rates and net exports in emerging market economies. The model accomplishes this by decomposing interest rates into an international rate and a country risk component, and by making labor demand sensitive to movements in these rates via a working capital constraint imposed on the representative firm. Moreover, it proposes two approaches to determining the stochastic processes for these interest rates: the independent country risk case and the induced country risk case. The induced country risk model calibrated to Argentine data reproduces the country’s business cycle facts well. However, the results are sensitive to certain parameters and specifications which are not properly set in accordance with developing economy data. Hence, a Bayesian approach is used to verify the model results. The estimation results highlight some areas for improvement in the model. First, certain key parameters of the model are difficult to inform by existing data. Second, the mechanisms through which the model tries to explain key developing economy business cycle facts are important, but need to be augmented in some way. In particular, more structure needs to be added into the model of default risk to help capture the dynamics of interest rates and output more fully.
small open economy, bayesian DSGE, real business cycles, country risk premium, interest rate shocks, countercyclical interest rates
MSc in Economics
Econometrics | Economic Policy | Finance
CONTI, Seigmund Vincent Roque.
Bayesian Analysis of Country Risk Premia in Developing Small Open Economies. (2010). Dissertations and Theses Collection (Open Access).
Available at: http://ink.library.smu.edu.sg/etd_coll/73