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Contingent Reserves Management: an Applied Framework

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  • Ricardo J. Caballero G.
  • Stavros Panageas

Abstract

One of the most serious problems that a central bank in an emerging market economy can face, is the sudden reversal of capital inflows. Hoarding international reserves can be used to smooth the impact of such reversals, but these reserves are seldom sufficient and always expensive to hold. In this paper we argue that adding richer hedging instruments to the portfolios held by central banks can significantly improve the efficiency of the anti-sudden-stop mechanism. We illustrate this point with a simple quantitative hedging model, where optimally used options and futures on the S&P100’s implied volatility index (VIX), increase the expected reserves available during sudden stops by as much as 40 percent.

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File URL: http://www.bcentral.cl/estudios/revista-economia/2005/ago/Vol8N2ago2005pp45_56.pdf
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Bibliographic Info

Article provided by Central Bank of Chile in its journal Economía Chilena.

Volume (Year): 8 (2005)
Issue (Month): 2 (August)
Pages: 45-56

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Handle: RePEc:chb:bcchec:v:8:y:2005:i:2:p:45-56

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  1. Caballero, Ricardo J. & Panageas, Stavros, 2008. "Hedging sudden stops and precautionary contractions," Journal of Development Economics, Elsevier, vol. 85(1-2), pages 28-57, February.
  2. Ricardo J. Caballero & Arvind Krishnamurthy, 2003. "Inflation Targeting and Sudden Stops," NBER Working Papers 9599, National Bureau of Economic Research, Inc.
  3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  4. Jaewoo Lee, 2004. "Insurance Value of International Reserves," IMF Working Papers 04/175, International Monetary Fund.
  5. Laurence M. Ball & Niamh Sheridan, 2004. "Does Inflation Targeting Matter?," NBER Chapters, in: The Inflation-Targeting Debate, pages 249-282 National Bureau of Economic Research, Inc.
  6. Pablo García & Claudio Soto, 2004. "Large Hoardings of International Reserves: Are They Worth It?," Working Papers Central Bank of Chile 299, Central Bank of Chile.
  7. Reinhart, Carmen & Calvo, Guillermo, 1999. "Capital Flow Reversals,the Exchange Rate Debate,and Dollarization," MPRA Paper 8951, University Library of Munich, Germany.
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