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A Global Safe Asset for and from Emerging Market Economies

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  • Brunnermeier, Markus K
  • Huang, Lunyang

Abstract

This paper examines international capital flows induced by flight-to-safety and proposes a new global safe asset. In the model domestic investors have to co-invest in a safe asset along with their physical capital. At times of crisis, investors replace the initially safe domestic government bonds with safe US Treasuries and fire-sell part of their capital. The reduction in physical capital lowers GDP and tax revenue, leading to increased default risk justifying the loss of the government bond's safe-asset status. We compare two ways to mitigate this self-fulfilling scenario. In the "buffer approach" international reserve holding reduces the severity of a crisis. In the "rechannelling approach'' flight-to-safety capital flows are rechannelled from international cross-border flows to flows across two EME asset classes. The two asset classes are the senior and junior bond of tranched portfolio of EME sovereign bonds.

Suggested Citation

  • Brunnermeier, Markus K & Huang, Lunyang, 2018. "A Global Safe Asset for and from Emerging Market Economies," CEPR Discussion Papers 13387, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:13387
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    References listed on IDEAS

    as
    1. Gary Gorton & Stefan Lewellen & Andrew Metrick, 2012. "The Safe-Asset Share," American Economic Review, American Economic Association, vol. 102(3), pages 101-106, May.
    2. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-661, September.
    3. repec:oup:ecpoli:v:32:y:2017:i:90:p:175-219. is not listed on IDEAS
    4. Markus K. Brunnermeier & Sam Langfield & Marco Pagano & Ricardo Reis & Stijn Van Nieuwerburgh & Dimitri Vayanos, 2017. "ESBies: safety in the tranches," Economic Policy, CEPR;CES;MSH, vol. 32(90), pages 175-219.
    5. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 91-116.
    6. repec:aea:jecper:v:31:y:2017:i:3:p:29-46 is not listed on IDEAS
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    More about this item

    Keywords

    Capital Flows; Flight to safety; SBBS; sovereign bond backed securities; sudden stop;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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