Seminario CEDE - Jorge Mondragón Minero

The Original Sin Hypothesis states that emerging economies are restricted to issue external debt in foreign currencies. However, little attention has been given to the question: Which foreign currency should external debt be issued? In this paper, I study external debt in foreign currency by emerging economies and its link to default risk. I document empirically that as default risk increases, the share of external debt issued in the foreign currency linked to trade falls. I build a real sovereign default model where a small open economy issues debt in two different foreign currencies and faces fluctuations to the real exchange rates associated with them. Theoretically and quantitatively, the model replicates the negative relationship between spreads and the share of debt issued in the foreign currency linked to trade. Lastly, the model matches the fluctuations in share of foreign currency sovereign external debt issued in US dollars by Argentina from 2010 to 2020.