Document Type : Research Paper

Authors

• mohammad feghikashani ¹
• Parvin Yahyavi ²

¹ Assistant Professor, Faculty of Economics, Allameh Tabataba’i University

² PhD Student, Faculty of Economics, Allameh Tabataba’i University, Tehran, and Officer at International Bureau of Central Bank of Islamic Republic of Iran

Abstract

This paper takes a novel perspective in analyzing theoretically how the sovereign wealth funds (SWFs) would impact on the sovereign risk, and thereby, the financial sector and, due to some frictions, the real sector of its owner economy. This happens as we suggest SWFs could help in mitigating the extant financial markets incompleteness. In a standard dynamic (continuous time) stochastic partial equilibrium model, it is shown how the SWFs would, under certain conditions, mitigate its owner sovereign risk, in which case it leads to the possibility of impacting on external financing costs of financial intermediaries and corporate sector. In particular, we explore how the sensitivity of default and/or financial distress and/or debt restructuring against (domestic and/or foreign) adverse shocks to the economy would be less, when there is a SWF in the economy in comparison with when the economy lacks it. This is investigated for two sources of financing the SWF. Further, we argue how the costs and benefits of establishing the SWF would be affected by the (relative) size of SWF, its type, and the state of the financial (surplus) capacity in time of setting up the SWF. The externality associated with the establishment of the SWF for the sovereign risk and formation of the new channel for the transmission of monetary and fiscal policies have been examined too. Mutual interactions between the SWF and the monetary and fiscal policy within the analytical framework have been analyzed as well.

Keywords

• Sovereign Wealth Fund
• Sovereign Risk
• Default Probability
• Sovereign Financial Capacity
• Distance to Default
• Geometric Brownian Motion