Weather Variability and Default Risk: Evidence from El Niño Southern Oscillation

Abstract

This project explores how hetereogenous sensitivities to changes in the weather conditions across sectors impact the cost of sovereign debt and optimal transfers in countries prone to harmful weather phenomena. The issuance of sovereign debt is costlier in such countries due to the additional source of risk caused by these phenomena, increasing their default probabilities during periods of bad weather. The allocation of public resources in those economies is complex due to the differences in the sensitivities of weather shocks across sectors and their interaction in the economy. To conduct this analysis, I use sectoral data on production from eight economic sectors in Peru and conduct a non-linear SVAR analysis to show how “El Niño Southern Oscillation” impacts heterogeneously across sectors. For example, the production of manufacturing and service sectors increases when the economy faces a small weather shock. In contrast, large shocks cause contractions in almost all sectors except for construction and electricity, which production is essential for the reconstruction process after a disaster. With these results, I will build a sovereign default model for a multisector economy with production networks. Sectors will face working capital requirements that they cover using government transfers since they are restricted to issuing international debt. I will calibrate this model to match the results from the SVAR and the average risk premium. Then, I will perform a counterfactual analysis to find the optimal transfer allocation across sectors.

Christian Velasquez

Ph.D. Candidate

My research interests include Macroeconomics of Climate Change, International finance, and Small Open Economies.