TY  - JOUR
AU  - Mendoza,Enrique G.
AU  - Yue,Vivian Z.
TI  - A Solution to the Default Risk-Business Cycle Disconnect
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13861
PY  - 2008
Y2  - March 2008
UR  - http://www.nber.org/papers/w13861
L1  - http://www.nber.org/papers/w13861.pdf
N1  - Author contact info:
Enrique G. Mendoza
Department of Economics
University of Maryland
College Park, MD 20742
Tel: 301/405-3845
Fax: 301/405-7835
E-Mail: mendozae@econ.umd.edu

Vivian Z. Yue
Department of Economics
19 West 4th Street
New York University
New York, NY 10012
Tel: 212/998-8963
E-Mail: zy3@nyu.edu
AB  - We propose a model that solves the crucial disconnect between business cycle models that treat default risk as an exogenous interest rate on working capital, and sovereign default models that treat output fluctuations as an exogenous process with ad-hoc default costs. The model replicates observed output dynamics around defaults, countercyclical spreads, high debt ratios, and key business cycle moments. Three features of the model are central for these results: working capital loans pay for imported inputs; default triggers an efficiency loss as imported inputs are replaced by imperfect domestic substitutes; and default on public and private foreign obligations occurs simultaneously. 
ER  -