IJPAM: Volume 108, No. 2 (2016)

SOVEREIGN DEFAULT IN A CURRENCY AREA:
A MONETARY GENERAL EQUILIBRIUM MODEL

Adrian Hernandez-del-Valle$^1$, Claudia I. Martínez-Garcia$^2$, Francisco Venegas-Martínez$^3$
$^{1,2,3}$Escuela Superior de Economía of the Instituto Politécnico Nacional
Plan de Agua Prieta No. 66, Miguel Hidalgo, C.P. 11340
Mexico City, MEXICO

Abstract. Real exchange rate overvaluation can induce default. In a currency area formed by two countries, we prove that if prices differ even slightly then inflations will diverge persistently and monetary policy will be unable to suit all currency area members. In fact, it will affect area members inversely. We show that risk premia are time-varying and determined by real exchange rate overvaluation. Finally, we find a transmission mechanism from the overvaluation of the real exchange rate of a currency area member to his default.

Received: February 6, 2016

Revised: February 6, 2016

Published: October 1, 2016

AMS Subject Classification: 90A09, 91B28

Key Words and Phrases: currency areas, sovereign default, cash-in-advance, monetary general equilibrium, stochastic pricing kernel, purchasing power parity, time-varying risk premia
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DOI: 10.12732/ijpam.v108i2.4 How to cite this paper?

Source:
International Journal of Pure and Applied Mathematics
ISSN printed version: 1311-8080
ISSN on-line version: 1314-3395
Year: 2016
Volume: 108
Issue: 2
Pages: 227 - 261


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