Specification of a Stochastic Simulation Model for Assessing Debt Sustainability in Emerging Market Economies

Abstract

This paper documents the specification of a model that was constructed to assess debt sustainability in emerging market economies. Key features of the model include external and fiscal sectors, which allow assessment of external and public debt in a unified framework; public and external debt, which both have an explicit maturity structure along with a distinction between denomination in domestic versus foreign currency to facilitate debt management analysis; monetary and fiscal policy, which are endogenous and specified using explicit forward-looking policy rules; an endogenous risk premium on public and external debt; and a mechanism for invoking a sudden stop in private capital flows. The paper provides an overview of the basic structure of the model, outlines the methodology used to calibrate the parameters, and illustrates the key properties of the model with reference to dynamic responses of selected variables to shocks of interest.