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

  • Sewon Hur
  • Illenin O. Kondo

Emerging economies, unlike advanced economies, have accumulated large foreign reserve holdings. 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 reducing debt rollover crises ("sudden stops"), akin to the role of bank reserves in preventing bank runs. We find that a small, unexpected, and permanent increase in rollover risk accounts for the outburst of sudden stops in the late 1990s, the subsequent increase in foreign reserves holdings, and the salient resilience of emerging economies to sudden stops ever since. Finally, we show that a policy of pooling reserves can substantially reduce the reserves needed by emerging economies.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 1073.

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Date of creation: 2013
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Handle: RePEc:fip:fedgif:1073
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  1. Bianchi, Javier & Hatchondo, Juan Carlos & Martinez, Leonardo, 2013. "International reserves and rollover risk," Working Paper 13-01, Federal Reserve Bank of Richmond, revised 01 Jun 2013.
  2. Ceyhun Bora Durdu & Enrique G. Mendoza & Marco E. Terrones, 2007. "Precautionary Demand for Foreign Assets in Sudden Stop Economies: An Assessment of the New Merchantilism," NBER Working Papers 13123, National Bureau of Economic Research, Inc.
  3. Akıncı, Özge, 2013. "Global financial conditions, country spreads and macroeconomic fluctuations in emerging countries," Journal of International Economics, Elsevier, vol. 91(2), pages 358-371.
  4. Giorgio Primiceri & Alexander Monge-Naranjo & Francisco Buera, 2008. "Learning the Wealth of Nations," 2008 Meeting Papers 179, Society for Economic Dynamics.
  5. Cristina Arellano & Ananth Ramanarayanan, 2012. "Default and the Maturity Structure in Sovereign Bonds," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 187 - 232.
  6. Guillermo A. Calvo & Alejandro Izquierdo & Luis Fernando Mejía, 2004. "On the Empirics of Sudden Stops: The Relevance of Balance-Sheet Effects," IDB Publications (Working Papers) 6516, Inter-American Development Bank.
  7. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  8. Laura Alfaro & Fabio Kanczuk, 2007. "Optimal reserve management and sovereign debt," Working Paper Series 2007-29, Federal Reserve Bank of San Francisco.
  9. Ennis, Huberto M. & Keister, Todd, 2003. "Economic growth, liquidity, and bank runs," Journal of Economic Theory, Elsevier, vol. 109(2), pages 220-245, April.
  10. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  11. Guillermo A. Calvo & Alejandro Izquierdo & Rudy Loo-Kung, 2012. "Optimal Holdings of International Reserves: Self-Insurance against Sudden Stop," NBER Working Papers 18219, National Bureau of Economic Research, Inc.
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