Sovereign Default, Interest Rates and Political Uncertainty in Emerging Markets

Emerging economies tend to experience larger political uncertainty and more default episodes than developed countries. This paper studies the effect of political uncertainty on sovereign default and interest rate spreads in emerging markets. The paper develops a quantitative model of sovereign debt and default under political uncertainty in a small open economy that captures some of the main empirical regularities in emerging economies: default occurs in equilibrium and interest rate spreads and default risk are countercyclical. Consistent with empirical evidence, the quantitative analysis shows that higher levels of political uncertainty significantly raise the default frequency and both the level and volatility of the spreads.