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Reserve Uncertainty and the Supply of International Credit

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  • Joshua Aizenman
  • Nancy Marion

Abstract

This paper examines how increased uncertainty about an emerging market's international reserves affects the willingness of foreign investors to supply international credits. We illustrate the relevance of this concern for South Korea during the recent financial crisis. Using available information about Korea's reserves at the onset of the crisis, we show that 'usable' reserves turned out to be much lower than what a reasonable forecast would have predicted. We then develop a model of an emerging-market economy where there is sovereign risk and moral hazard is a problem because agents expect the emerging market to bail out creditors with its reserves. We show that reserve uncertainty has a non-linear effect on the supply of credit. When the expected reserve position of an emerging market is large relative to the potential bailout in bad states of nature, reserve volatility does not matter. However, the same amount of reserve volatility can cause a large reduction in the supply of international credit if the emerging market's foreign debt is large enough or if the collapse of output forces the private sector to downgrade its priors about repayment possibilities. In addition, reserve volatility can reduce international credit if investors become more pessimistic about the emerging market's reserve position.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7202.

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Date of creation: Jul 1999
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Publication status: published as Journal of Money, Credit and Banking, Vol. 34, no. 3, part 1 (August 2002): 631-649
Handle: RePEc:nbr:nberwo:7202

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  1. Aizenman, Joshua, 1989. "Country Risk, Incomplete Information and Taxes on International Borrowing," Economic Journal, Royal Economic Society, vol. 99(394), pages 147-61, March.
  2. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  3. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
  4. Alba, Pedro & Bhattacharya, Amar & Claessens, Stijn & Ghosh, Swati & Hernandez, Leonardo, 1998. "Volatility and contagion in a financially integrated world : lessons from East Asia's recent experience," Policy Research Working Paper Series 2008, The World Bank.
  5. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper tigers? A model of the Asian crisis," Research Paper 9822, Federal Reserve Bank of New York.
  6. Aizenman, Joshua & Marion, Nancy, 1999. "Volatility and Investment: Interpreting Evidence from Developing Countries," Economica, London School of Economics and Political Science, vol. 66(262), pages 157-79, May.
  7. Joshua Aizenman & Stephen Turnovsky, 1999. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," Discussion Papers in Economics at the University of Washington 0044, Department of Economics at the University of Washington.
  8. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper 98-10, Federal Reserve Bank of Atlanta.
  9. Boyd, John H & Smith, Bruce D, 1994. "How Good Are Standard Debt Contracts? Stochastic versus Nonstochastic Monitoring in a Costly State Verification Environment," The Journal of Business, University of Chicago Press, vol. 67(4), pages 539-61, October.
  10. Steven Radelet & Jeffrey D. Sachs, 1998. "The East Asian Financial Crisis: Diagnosis, Remedies, Prospects," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 29(1), pages 1-90.
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Cited by:
  1. Joshua Aizenman & Michael M. Hutchison & Yothin Jinjarak, 2011. "What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk," NBER Working Papers 17407, National Bureau of Economic Research, Inc.
  2. Joshua Aizenman, 2002. "Financial Opening: Evidence and Policy Options," NBER Working Papers 8900, National Bureau of Economic Research, Inc.
  3. Claudio Soto G. & Alberto Naudon D. & Eduardo López E. & Álvaro Aguirre R., 2004. "About International Reserve Adequacy: The Case of Chile," Journal Economía Chilena (The Chilean Economy), Central Bank of Chile, vol. 7(3), pages 5-34, December.
  4. Valev, Neven T., 2007. "Uncertainty and international debt maturity," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 17(4), pages 372-386, October.
  5. Demarmels, Ricarda & Fischer, Andreas M, 2003. "Understanding Reserve Volatility in Emerging Markets: A Look at the Long-Run," CEPR Discussion Papers 3908, C.E.P.R. Discussion Papers.
  6. Bernd Hayo, 2005. "Perspektiven einer Asiatischen Währungsunion," Marburg Working Papers on Economics 200508, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  7. David Fernando LOPEZ ANGARITA, 2006. "Nivel óptimo de Reservas Internacionales y crisis cambiaria en Colombia," ARCHIVOS DE ECONOMÍA 003273, DEPARTAMENTO NACIONAL DE PLANEACIÓN.
  8. Ricarda Demarmels & Andreas M. Fischer, 2002. "Understanding Reserve Volatility in Emerging Markets: A Look at the Last Thirty Years," Working Papers 02.02, Swiss National Bank, Study Center Gerzensee.
  9. Catherine S. F. Ho & M. Ariff, 2008. "The Role of Non-Parity Fundamentals in Exchange Rate Determination: Australia and the Asia Pacific Region," CARF F-Series CARF-F-125, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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