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Optimal Reserve Management and Sovereign Debt

  • Laura Alfaro
  • Fabio Kanczuk

To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model that incorporates willingness-to-pay incentive problems. In this setup, debt and assets are not perfect substitutes, as reserves can be used even after a country has defaulted. We calibrate the model to a sample of emerging markets. We obtain that the reserve accumulation does not play a quantitatively important role in this model. In fact, the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13216.

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Date of creation: Jul 2007
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Publication status: published as Alfaro, Laura & Kanczuk, Fabio, 2009. "Optimal reserve management and sovereign debt," Journal of International Economics, Elsevier, vol. 77(1), pages 23-36, February.
Handle: RePEc:nbr:nberwo:13216
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