Financial Friction Sources in Emerging Economies : Structural Estimation of Sovereign Default Models

There are two literature strands that explain stylized facts in emerging economies: the stochastic productivity trend or financial frictions. However, financial frictions are driven by both trend and stationary productivity shocks, thus distinguishing their impact from the direct role of output fluctuations is essential. We estimate sovereign default models, full-nonlinear dynamic stochastic general equilibrium (DSGE) with micro-founded financial imperfections, applying a particle filter, and evaluate the source of financial frictions. The main finding is that stationary shocks rather than trend shocks account for financial frictions and the resulting countercyclicality, except for the post-1977 period in Mexico; however, the exception disappears for 1902–2005 as long-run data. The sources of financial frictions are determined by the persistence and volatility of shocks, asymmetric domestic cost of sovereign default, and mismatch between sovereign default and business cycles