Country Risk, Foreign Borrowing and the Social Discount Rate in an Open Developing Economy

Sebastian Edwards

NBER Working Paper No. 1651 (Also Reprint No. r0759)
Issued in June 1985
NBER Program(s):International Trade and Investment, International Finance and Macroeconomics

Most discussions on the social rate of discount have assumed that the economy under consideration is isolated from the rest of the world, and that there are no capital movements. This paper explicitly analyzes the determination of the social rate of discount in a small open developing economy. It is shown that under general conditions, the discount rate will bea weighted average of the marginal return to capital in the private sector(p), the rate of time preference (r), and the marginal cost of foreign indebtedness (n).It is also shown that unless the country faces an upward-sloping supply curve for foreign funds the weights of p and r will be zero. Finally, it is shown that if the country in question faces a foreign borrowing constraint imposed from abroad, the social rate of discount becomes equal to a weighted average of the domestic marginal return to capital and the rate of time preferences. Data for a group of LDCs is then used to show that financial markets have indeed attached a default country risk premium to LDCs. This provides some evidence in favor of the hypothesis that developing countries face an upward-sloping supply curve of foreign funds, and that, in general, the social rate of discount should be a weighted average of p, r and n. Finally,some numerical examples are used to show that ignoring the open economy aspects can result in a substantial overstatement of the social rate of discount.

download in pdf format
   (373 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w1651

Published: Edwards, Sebastian. "Country Risk, Foreign Borrowing and the Social Discount Rate in and Open Developing Economy," Journal of International Money and Finance, Vol. 5, Supplement, March 1986, pp. S79-S96. citation courtesy of

Users who downloaded this paper also downloaded* these:
Caplin and Leahy w7983 The Social Discount Rate
Poterba w6263 The Rate of Return to Corporate Capital and Factor Shares: New EstimatesUsing Revised National Income Accounts and Capital Stock Data
Mendoza and Yue w13861 A Solution to the Disconnect between Country Risk and Business Cycle Theories
Eaton, Gersovitz, and Stiglitz w1894 The Pure Theory of Country Risk
Edwards w1172 LDC's Foreign Borrowing and Default Risk: An Empirical Investigation
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us