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

Listed author(s):
  • 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
Handle: RePEc:fip:fedgif:1073
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