engleski

Balance Sheet Effects and Original Sinners’ Risk Premiums

This paper describes an empirical model of country risk premiums and its determinants, relying on recent theories of balance sheet effects. We approach the latter by introducing a novel approach to country risk premiums that assumes nominal exchange rates can move away or towards equilibrium exchange rates, which allows exchange rate movements towards equilibrium to stimulate favorable competitiveness effects as opposed to adverse balance sheet effects. We investigate eight European emerging economies that suffer from “original sin”, over the period 2001-2013, using pooled mean group estimator of dynamic panel error correction model. This methodology improves estimation efficiency and model performance, but it also allows differentiation between long- and short-run country risk premium determinants. We find that in the long-run, country risk premiums increase in response to higher inflation and to higher total debt to GDP ratio, while they move in the opposite direction when real GDP growth rate rises. Our results suggest that in the short-run, higher external debt service caused by exchange rate depreciation, i.e. the balance sheet effect, and market volatility tend to raise risk premiums, while higher international reserves and the federal funds rate tend to decrease them. Moreover, we show that the negative balance sheet effect is much stronger than the potentially favorable competitiveness effect, and that the rise in risk premiums is not due to the increase in the size of external debt, but due to larger debt burden represented by balance sheet effects.

balance sheet effect; country risk premiums; emerging Europe; euroization; original sin

nije evidentirano