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A theory of rollover risk, sudden stops, and foreign reserves

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  • Hur, Sewon
  • Kondo, Illenin O.

Abstract

Emerging economies have accumulated very large foreign reserve holdings since the turn of the century. We argue that this policy is an optimal response to an increase in foreign debt rollover risk. In our model, reserves play a key role in endogenously reducing debt rollover crises (“sudden stops”) by allowing governments to be solvent in more states of the world. Using a dynamic multi-country environment with learning, we find that a relatively small unanticipated increase in rollover risk jointly accounts for (i) the outburst of sudden stops in the late 1990s, (ii) the increase in foreign reserves holdings, and (iii) the subsequent reduction of sudden stops in emerging economies. We also show that a policy of pooling reserves may substantially reduce reserves because mutual insurance across countries dampens rollover risk.

Suggested Citation

  • Hur, Sewon & Kondo, Illenin O., 2016. "A theory of rollover risk, sudden stops, and foreign reserves," Journal of International Economics, Elsevier, vol. 103(C), pages 44-63.
  • Handle: RePEc:eee:inecon:v:103:y:2016:i:c:p:44-63
    DOI: 10.1016/j.jinteco.2016.08.006
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    Cited by:

    1. Choi, Woo Jin & Taylor, Alan M., 2017. "Precaution Versus Mercantilism: Reserve Accumulation, Capital Controls, and the Real Exchange Rate," CEPR Discussion Papers 11963, C.E.P.R. Discussion Papers.
    2. repec:eee:macchp:v2-1697 is not listed on IDEAS
    3. Fogli, Alessandra & Perri, Fabrizio, 2015. "Macroeconomic volatility and external imbalances," Journal of Monetary Economics, Elsevier, vol. 69(C), pages 1-15.
    4. Fabio Comelli, 2015. "Estimation and out-of-sample Prediction of Sudden Stops; Do Regions of Emerging Markets Behave Differently from Each Other?," IMF Working Papers 15/138, International Monetary Fund.
    5. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, Elsevier.
    6. Bocola, Luigi & Lorenzoni, Guido, 2017. "Financial Crises and Lending of Last Resort in Open Economies," Staff Report 557, Federal Reserve Bank of Minneapolis.
    7. Fabrice Tourre, 2016. "Debt Runs and the Value of Liquidity Reserves," 2016 Meeting Papers 709, Society for Economic Dynamics.
    8. Samer Shousha, 2017. "International Reserves, Credit Constraints, and Systemic Sudden Stops," International Finance Discussion Papers 1205, Board of Governors of the Federal Reserve System (U.S.).
    9. repec:eee:dyncon:v:90:y:2018:i:c:p:284-309 is not listed on IDEAS
    10. Luigi Bocola & Guido Lorenzoni, 2017. "Financial Crises, Dollarization, and Lending of Last Resort in Open Economies," NBER Working Papers 23984, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Rollover risk; Optimal reserves; Endogenous sudden stops; Debt crises; Learning;

    JEL classification:

    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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