Bengui, JulienNguyen, Ha2012-03-192012-03-192011-11-01https://hdl.handle.net/10986/3636Most emerging markets do not borrow much internationally in their own currency, although doing that has been argued as an attractive insurance mechanism. This phenomenon, commonly labeled "the original sin", has mostly been interpreted as evidence of the countries' inability to borrow in domestic currency from abroad. This paper provides a novel explanation for that phenomenon: not that countries are unable to borrow abroad in their currency, they might not need to do so. In the model, the small prevalence of external borrowing in domestic currency arises as an equilibrium outcome, despite the absence of exogenous frictions or limits on market participation. The equilibrium outcome is driven by the fact that domestic and foreign lenders have differential consumption baskets. In particular, a large part of domestic lenders' consumption basket is denominated in domestic currency whereas all of foreign lenders' is in dollars. A depreciation of domestic currency, which tends to occur in bad times, is therefore less harmful to domestic savers than to foreign investors. This makes domestic lenders require a lower premium than foreign lenders on domestic currency debt. For plausible calibrations, this consumption basket effect can induce foreign investors to pull out of the domestic currency debt market.CC BY 3.0 IGOACCELERATORAGGREGATE CONSUMPTIONASSET POSITIONASSETSBAILOUTBALANCE SHEETBENCHMARKBILLBONDBOND HOLDERSBOND MARKETBOND MARKETSBOND RETURNBONDSBORROWING COUNTRYBUDGET CONSTRAINTBUDGET CONSTRAINTSBUSINESS CYCLECAPITAL ACCUMULATIONCAPITAL FLOWSCASH HOLDINGSCLAIMANTSCOMPETITIVE MARKETCONSUMPTION BASKETCONSUMPTION BASKETSCONSUMPTION DECLINECOUNTRY RISKCREDIT MARKETSCURRENCYCURRENCY COMPOSITIONCURRENCY EXPOSURESCURRENT ACCOUNTCURRENT ACCOUNT IMBALANCESDEBTDEBT DENOMINATIONDEBT MARKETDEPRECIATIONDEVALUATIONSDEVELOPING COUNTRIESDEVELOPING COUNTRYDEVELOPMENT POLICYDOLLAR BONDDOLLAR BONDSDOLLAR DEBTDOLLAR PRICEDOMESTIC CREDITDOMESTIC CURRENCIESDOMESTIC CURRENCYDOMESTIC ECONOMYDOMESTIC MARKETDOMESTIC MONETARY POLICYDOMESTIC WORKERSECONOMIC CONDITIONSECONOMIC RESEARCHELASTICITYELASTICITY OF SUBSTITUTIONEMERGING ECONOMIESEMERGING MARKETEMERGING MARKET ECONOMIESEMERGING MARKETSEMPLOYMENTEQUATIONSEQUILIBRIUMEQUILIBRIUM CONDITIONSEXCESS RETURNEXCHANGE RATEEXCHANGE RATESEXOGENOUS RATEEXPENDITURESEXTERNAL BORROWINGEXTERNAL DEBTEXTERNALITIESEXTERNALITYFINANCIAL CRISESFINANCIAL EXCHANGEFINANCIAL FRAGILITYFINANCIAL INSTABILITYFOREIGN CURRENCYFOREIGN DEBTFOREIGN INCOMEFOREIGN INVESTORFOREIGN INVESTORSFOREIGN LENDERSFOREIGN MARKETSGDPHEDGESHOLDINGHOLDINGSIMPLICIT CONTRACTIMPLICIT CONTRACTSIMPORTSINCOME SHOCKSINCOMPLETE MARKETSINFLATIONINSTRUMENTINSURANCEINSURERINTEREST RATEINTERNATIONAL BANKINTERNATIONAL BORROWINGINTERNATIONAL CAPITALINTERNATIONAL CAPITAL FLOWSINTERNATIONAL CURRENCYINTERNATIONAL DEBTINTERNATIONAL DEBT MARKETSINTERNATIONAL DIVERSIFICATIONINTERNATIONAL ECONOMICSINTERNATIONAL FINANCEINTERNATIONAL PRICELABOR DEMANDLABOR MARKETLABOR SUPPLYLACK OF CREDIBILITYLEVYLOANLOAN MARKETLOCAL CURRENCIESLOCAL CURRENCYMACROECONOMICSMARKET STRUCTURESMIDDLE INCOME COUNTRIESMONETARY POLICYMONEY HOLDINGMONEY HOLDINGSMONEY SUPPLYMORAL HAZARDMUTUAL FUNDSNEGATIVE SHOCKNOMINAL WAGEOPEN ECONOMYPOLITICAL ECONOMYPORTFOLIOPORTFOLIO CHOICEPORTFOLIO CHOICESPORTFOLIO HOLDINGSPORTFOLIOSPRIVATE CREDITPRODUCTION FUNCTIONPRODUCTION FUNCTIONSPRODUCTION STRUCTUREPRODUCTIVITYRANDOM VARIABLESREAL EXCHANGE RATEREAL SHOCKREAL SHOCKSREAL WAGESREPAYMENTSRETURNRISK AVERSERISK PREMIUMRISK SHARINGSHARE OF CAPITALSMALL COUNTRIESSMALL COUNTRYSMALL ECONOMYSOCIAL RISKSSOURCE OF UNCERTAINTYSTANDARD DEVIATIONSTANDARD DEVIATIONSSTEADY STATESTEADY STATE LEVELSTICKY PRICESSTICKY WAGESSUPPLIERSSUPPLY SHOCKTOTAL OUTPUTTRADABLE GOODTRADABLE GOODSUTILITY FUNCTIONVOLATILITIESVOLATILITYWAGESWEALTHWORLD DEVELOPMENT INDICATORSWORLD INTEREST RATEWorld Bank10.1596/1813-9450-5870