Pricing Sovereign Debt in Resource-Rich Economies

Abstract

How do oil price movements affect sovereign spreads in an oil-dependent economy? I develop a stochastic general equilibrium model of an economy exposed to co-moving oil price and output processes, with endogenous sovereign default risk. The model explains a large proportion of business cycle fluctuations in interest-rate spreads in oil-exporting emerging market economies, particularly the countercyclicallity of interest rate spreads and oil prices. Higher risk-aversion, more impatient governments, larger oil shares and a stronger correlation between domestic output and oil price shocks all lead to stronger co-movements between risk premiums and the oil price.

Keywords: Market interest rates, Economic conditions, Financial crises, Real interest rates, Commodity price fluctuations, Risk premium, natural resources, sovereign debt, and default, development, WP, emerge market economy, countercyclical, oil price, inter-temporal, sovereign default

JEL Classification: E32, E44, F34, G15, H63, O11, E01, F16, G21, Q02,