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Optimal reserve management and sovereign debt

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Author Info
Alfaro, Laura
Kanczuk, Fabio

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Abstract

Most models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign's willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why do not sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the reserve accumulation does not play a quantitatively important role in this model. In fact, we find the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.

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Publisher Info
Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 77 (2009)
Issue (Month): 1 (February)
Pages: 23-36
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Handle: RePEc:eee:inecon:v:77:y:2009:i:1:p:23-36

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Web page: http://www.elsevier.com/locate/inca/505552

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Keywords: Foreign reserves Sovereign debt Default Sudden stops Sustainability;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Blackwell Publishing, vol. 48(2), pages 289-309, April. [Downloadable!] (restricted)
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  5. Ricardo Caballero & Stavros Panageas, 2004. "Contingent reserves management: an applied framework," Working Papers 05-2, Federal Reserve Bank of Boston. [Downloadable!]
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  6. Dani Rodrik & Andres Velasco, 1999. "Short-Term Capital Flows," NBER Working Papers 7364, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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    • Eaton, Jonathan & Gersovitz, Mark & Stiglitz, Joseph E., 1986. "The pure theory of country risk," European Economic Review, Elsevier, vol. 30(3), pages 481-513, June. [Downloadable!] (restricted)
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  19. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany. [Downloadable!]
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  20. Frenkel, Jacob A & Jovanovic, Boyan, 1981. "Optimal International Reserves: A Stochastic Framework," Economic Journal, Royal Economic Society, vol. 91(362), pages 507-14, June. [Downloadable!] (restricted)
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  22. Jaewoo Lee, 2004. "Insurance Value of International Reserves: An Option Pricing Approach," IMF Working Papers 04/175, International Monetary Fund. [Downloadable!]
  23. Frankel, Jeffrey & Cavallo, Eduardo, 2004. "Does Openness to Trade Make Countries More Vulnerable to Sudden Stops, or Less? Using Gravity to Establish Causality," Working Paper Series rwp04-038, Harvard University, John F. Kennedy School of Government. [Downloadable!]
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  24. Romain Ranciere & Olivier Jeanne, 2006. "The Optimal Level of International Reserves for Emerging Market Countries: Formulas and Applications," IMF Working Papers 06/229, International Monetary Fund. [Downloadable!]
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  27. Olivier Jeanne, 2007. "International Reserves in Emerging Market Countries: Too Much of a Good Thing?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(2007-1), pages 1-80. [Downloadable!]
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Eliza, Nor & M., Azali & Law, Siong-Hook & Lee, Chin, 2008. "Demand For International Reserves in ASEAN-5 Economies," MPRA Paper 11735, University Library of Munich, Germany. [Downloadable!]
  2. Dirk Niepelt, 2008. "Debt Maturity without Commitment," Working Papers 08.05, Swiss National Bank, Study Center Gerzensee. [Downloadable!]
    Other versions:
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This page was last updated on 2009-11-22.

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