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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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Bibliographic Info

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, Royal Economic Society, vol. 99(394), pages 147-61, March.
  2. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper Tigers? A Model of the Asian Crisis," NBER Working Papers 6783, National Bureau of Economic Research, Inc.
  3. Roberto Chang & Andres Velasco, 1998. "Financial crises in emerging markets: a canonical model," Working Paper, Federal Reserve Bank of Atlanta 98-10, Federal Reserve Bank of Atlanta.
  4. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, Elsevier, vol. 21(2), pages 265-293, October.
  5. 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.
  6. Joshua Aizenman & Stephen Turnovsky, 1999. "Reserve Requirements on Sovereign Debt in the Presence of Moral Hazard -- on Debtors or Creditors?," Working Papers, University of Washington, Department of Economics 0044, University of Washington, Department of Economics.
  7. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
  8. 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.
  9. Aizenman, Joshua & Marion, Nancy, 1999. "Volatility and Investment: Interpreting Evidence from Developing Countries," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 66(262), pages 157-79, May.
  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. Aizenman, Joshua & Hutchison, Michael & Jinjarak, Yothin, 2011. "What is the Risk of European Sovereign Debt Defaults? Fiscal Space, CDS Spreads and Market Pricing of Risk," Santa Cruz Department of Economics, Working Paper Series qt2914v9fh, Department of Economics, UC Santa Cruz.
  2. David Fernando LOPEZ ANGARITA, 2006. "Nivel óptimo de Reservas Internacionales y crisis cambiaria en Colombia," ARCHIVOS DE ECONOMÍA 003273, DEPARTAMENTO NACIONAL DE PLANEACIÓN.
  3. Joshua Aizenman, 2004. "Financial Opening: Evidence and Policy Options," NBER Chapters, in: Challenges to Globalization: Analyzing the Economics, pages 473-498 National Bureau of Economic Research, Inc.
  4. Demarmels, Ricarda & Fischer, Andreas M., 2003. "Understanding reserve volatility in emerging markets: a look at the long-run," Emerging Markets Review, Elsevier, Elsevier, vol. 4(2), pages 145-164, June.
  5. Bernd Hayo, 2005. "Perspektiven einer Asiatischen Währungsunion," Marburg Working Papers on Economics, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung) 200508, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  6. 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.
  7. 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.
  8. 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, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo CARF-F-125, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  9. Valev, Neven T., 2007. "Uncertainty and international debt maturity," Journal of International Financial Markets, Institutions and Money, Elsevier, Elsevier, vol. 17(4), pages 372-386, October.

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