Currency Mismatch , Uncertainty and Debt Structure ∗

The importance of currency and maturity mismatches in the debt structure of emerging markets is an issue that can hardly be overemphasized. Yet, while many papers have explained how imbalances in the asset and liability structure of emerging markets can cause currency and financial crises, the factors that may have triggered such imbalances in the first place have received relatively little attention so far. The aim of the paper is to contribute to fill this gap, both at a theoretical and empirical level. We show that if (i) a significant share of the debt is denominated in foreign currency -creating a currency mismatchand (ii) borrowing is constrained by solvency, then currency mismatch can create and exacerbate a maturity mismatch. In particular, higher economic or political uncertainty tightens solvency constraints and tilts the debt profile towards short-term debt. The combination of currency mismatch and maturity mismatch increases the volatility of output growth in the short-run. Taking the model implications to the data, we find substantial empirical support for the model’s predictions using data for 30 open emerging market economies.