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Balance sheet effects and the country risk premium: An empirical investigation

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Abstract

Based on recent theories emphasizing financial imperfections, this paper is an empirical investigation of the link between a country's risk premium and the balance sheet effect of a devaluation. In a panel of emerging economies, balance sheet effects, due to increased external debt service after an unexpected real depreciation, significantly raise the risk premium. This result is robust to various checks and appears driven by those countries with the largest financial imperfections. Also, particularly large real depreciations turn out to be disproportionately important, meaning that balance sheet effects may be strongest at times of economic crisis. JEL no. F34, F41

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Correspondence to Alicia García Herrero.

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Berganza, J.C., Chang, R. & Herrero, A.G. Balance sheet effects and the country risk premium: An empirical investigation. Rev. World Econ. 140, 592–612 (2004) doi:10.1007/BF02659616

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Keywords

  • Balance sheet effects
  • devaluation
  • liability dollarization