| Some of the most salient features of developing countries are the high dependence on a few commodities to generate their export earnings and the heavy reliance on imported capital and intermediate goods to generate such output. In addition, these countries are usually subject to a high level of political uncertainty and high government instability. The first chapter of this work addresses the issue of external determinants of sovereign default risk and country spreads in emerging markets using a dynamic stochastic model of a small open economy with equilibrium default and international credit market frictions. A neoclassical model is used to analyze the properties of default risk and how they respond to shocks to terms of trade and US real interest rates. Different empirical studies have analyzed the effects of US interest rates and other external shocks on country spreads in emerging market economies but the theoretical analyses in the literature consider the law of motion of the country spread as given. This paper provides a model of endogenous risk of default to study the role of terms of trade and US real interest rate shocks on output and country spreads and the interaction between these variables. Spreads are very responsive to terms of trade shocks but are not affected by US interest rates. As observed in empirical studies, the model predicts that default incentives and default premia are countercyclical.; The next chapter studies the effects of political risk on foreign debt sustainability and default probability by explicitly introducing endogenous default in a stochastic general equilibrium model of a small open economy with two political parties. The parties have different social utility functions and take office according to an exogenous stochastic process. As observed in the data for emerging market economies, the model predicts that default incentives are higher in recessions and the higher is political uncertainty.; The third chapter explores the effects of political uncertainty on income tax and redistribution policies in a stochastic general equilibrium model. It considers an economy with two types of agents, stockholders and non-stockholders, and two political parties with different social utility functions. The two parties alternate in power according to an exogenous stochastic process. When the political party currently in office chooses its tax rate, there is an influence on stockholders' capital accumulation decisions and, via the effect on the changed wealth distribution next period, also on future tax policies. Hence, through this dynamic channel, it is possible for the ruling political party to influence future tax policies. The outcome is that the two parties tend to implement similar tax policies. The result is similar to those of spatial models of party competition, where political candidates under two party competition tend to move their political positions to the center in order to win the election. However, convergence occurs here through strategic manipulation of each other's policy choices. |
