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Title: The nonlinear nature of country risk Authors:  Jacek Kotlowski - SGH Warsaw School of Economics (Poland) [presenting]
Michal Brzoza-Brzezina - Narodowy Bank Polski (Poland)
Abstract: Country risk premia can substantially affect macroeconomic dynamics. We concentrate on one of their most important determinants - a country's net foreign asset position and - in contrast to the existing research - investigate its nonlinear link to risk premia. The importance of this particular nonlinearity is twofold. First, it bears a close relationship to debt crises. Second, such a nonlinear relationship is a standard ingredient of DSGE models, but its proper calibration/estimation is missing. Our estimation shows that indeed the link is highly nonlinear and helps to identify the NFA position where serious and posibly dangerous nonlinearities kick in at -70\% to -80\% of GDP. We also provide a proper calibration of the risk premium - foreign debt relationship applicable to DSGE models and demonstrate that the steady state NFA position matters for economic dynamics in such a model.