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Context 1
... left panel in Figure 6 shows the menu of spreads and next-period debt level combinations from which the sovereign can choose, keeping the level of a fixed at the mean value observed in the simulations and initial values for all state variables set at their means. In line with the results on the default sets, the spread is increasing in the end-of-period debt and the spread is higher under fixed than under flex for any given level of debt. ...
Context 2
... line with the results on the default sets, the spread is increasing in the end-of-period debt and the spread is higher under fixed than under flex for any given level of debt. 23 The right panel of Figure 6 shows how much the spreads-debt menu would worsen if the government were to accumulate zero reserves. Specifically, the right panel of Figure 6 compares the spread if the government were to accumulate zero reserves with the spread if the government were to accumulate the mean level of reserves. ...
Context 3
... The right panel of Figure 6 shows how much the spreads-debt menu would worsen if the government were to accumulate zero reserves. Specifically, the right panel of Figure 6 compares the spread if the government were to accumulate zero reserves with the spread if the government were to accumulate the mean level of reserves. The figure shows that spreads worsen significantly when a = 0, and especially so under a fixed exchange rate. ...
Context 4
... left panel in Figure 6 shows the menu of spreads and next-period debt level combinations from which the sovereign can choose, keeping the level of a fixed at the mean value observed in the simulations and initial values for all state variables set at their means. In line with the results on the default sets, the spread is increasing in the end-of-period debt and the spread is higher under fixed than under flex for any given level of debt. ...
Context 5
... line with the results on the default sets, the spread is increasing in the end-of-period debt and the spread is higher under fixed than under flex for any given level of debt. 20 The right panel of Figure 6 shows how much the spreads-debt menu would worsen if the government were to accumulate zero reserves. Specifically, the right panel of Figure 6 compares the spread if the government were to accumulate zero reserves with the spread if the government were to accumulate the mean level of reserves. ...
Context 6
... The right panel of Figure 6 shows how much the spreads-debt menu would worsen if the government were to accumulate zero reserves. Specifically, the right panel of Figure 6 compares the spread if the government were to accumulate zero reserves with the spread if the government were to accumulate the mean level of reserves. The figure shows that spreads worsen significantly when a = 0, and especially so under a fixed exchange rate. ...
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Citations
... Another strand of literature focuses on foreign reserve policies. Papers in this literature introduce different assumptions to motivate reserve accumulation, such as a shock to borrowing limit (Jeanne and Rancière 2011, Céspedes and Chang 2020, Matsumoto 2022), a liquidity shock (Hur and Kondo 2016), capital flow shocks (Cavallino 2019), sovereign default and endogenous borrowing cost (Hernández 2017, Bianchi, Hatchondo, and Martinez 2018, Bianchi and Sosa-Padilla 2020, self-fulfilling currency crisis (Bocola and Lorenzoni 2020), growth externality (Benigno et al. 2022), and collateral constraint on foreign borrowing (Shousha 2017). Jeanne and Sandri (2023) develop a model with liquidity shocks and pecuniary externalities to show that foreign reserve policy is necessary for countries with intermediate levels of financial development, similar to our result. ...
We provide a financial development perspective for the joint use of foreign reserves and capital controls. Empirical evidence indicates that countries with intermediate levels of financial development have the highest reserve-to-GDP ratios, but capital controls are negatively correlated with financial development. To explain this pattern, we develop a small-open-economy model featuring endogenous growth and liquidity shocks. Both reserves and capital controls are necessary to mitigate fire-sale externalities resulting from asset liquidation during liquidity crises. Our model captures financial development by the magnitude of liquidity shocks, thereby replicating the observed relationship between reserves, capital controls, and financial development.
... Our paper also draws on the literature on sovereign debt and international reserves (Alfaro and Kanczuk, 2009;Bianchi, Hatchondo and Martinez, 2018;Bianchi and Sosa-Padilla, 2023), which in turn builds on the workhorse sovereign default model (Eaton and Gersovitz, 1981;Aguiar and Gopinath, 2006;Arellano, 2008). Most of the literature also focuses on the case where investors are either risk-neutral or their holdings of sovereign bonds are too small to affect their marginal utility. ...
... 14 This calibration also implies that the model is consistent with Russia's positive net foreign asset position. As pointed out in Bianchi, Hatchondo and Martinez (2018) and Bianchi and Sosa-Padilla (2023), default incentives depend on the gross asset and debt position, but these are more sensitive to the latter. 15 Bai, Kim and Mihalache (2017) find that the debt duration for Russia is 6.83 years (using data for the period January 1993 -June 2009). ...
... In this context, FX reserve accumulation would help to smooth exchange rate volatility (Aizenman and Lee 2010;Benigno and Fornaro 2012;Korinek and Servén 2016;Rapetti, Skott, and Razmi 2012). The second argument highlights the role of reserves as a self-insurance policy, providing liquidity in times of stress (Aizenman and Lee 2007;Allegret and Allegret 2018;Arce, Bengui, and Bianchi 2019;Bastourre, Carrera, and Ibarlucía 2010;Bianchi and Sosa-Padilla 2020;Catao and Milesi-Ferretti 2014;Obstfeld, Shambaugh, and Taylor 2010). Aizenman and Lee (2007) show that EMEs countries holding large amounts of international reserves will be more able to withstand panics in financial markets, avoid contagion and manage sudden reversals in capital flows. ...
... Second, Hur & Kondo (2016), Bianchi et al. (2018), Bianchi & Sosa-Padilla (2022), and Suarez (2022) examine the optimal choice of foreign reserves and sovereign debt. In the presence of long-term debt, foreign reserves alter the cost of borrowing across states of nature and the resources available after a default. ...
... Consequently, the accumulation of international reserves in emerging market economies (EMEs) has become one of the most debated issues in open-economy macroeconomics (Chinn et al. 1999;Aizenman and Marion 2003;Dooley et al. 2004;Rancière 2006, 2011;Panageas 2007, 2008; Alfaro and Kanczuk 2009;Durdu et al. 2009;Benigno and Fornaro 2012;Calvo et al. 2012;Dominguez et al. 2012;Bianchi et al. 2013Bianchi et al. , 2018Arce et al. 2019;Bianchi and Sosa-Padilla 2020). Have many EMEs, in fact, accumulated excessive rather than adequate reserves? ...
This paper contributes to the theory of optimal international reserves by extending the Jeanne-Rancière (Econ J 121:905-930, 2011) endowment small open economy (SOE) model to a SOE with production that accounts for the main sources of economic growth. We, first, derive a richer analytical version of the optimal reserves formula in our set-up, essentially driven by labour-augmenting productivity and the saving rate. Then, under a plausible calibration based on 1975-2020 data averages for typical emerging market countries facing the risk of sudden stops in capital inflows, we find that the optimal reserves-to-output ratio is 7.5%, i.e., the mid-point in the range between that in Jeanne and Rancière (Econ J 121:905-930, 2011), of 9.1%, calibrated to the same sample of 34 middle-income countries, and that in Bianchi et al. (Am Econ Rev 108(9):2629-2670, 2018), of 6.0%, obtained in a different, sovereign debt model without capital and production. We explain the lower optimal reserves-to-output ratio relative to the endowment SOE by the role of capital accumulation as precautionary saving: the accumulated capital stock can potentially be used as a pledge to external creditors in obtaining borrowing, thereby insuring better a SOE against sudden stops. As the countries in our sample appear quite heterogeneous, we also compute the optimal reserves-to-output ratio by region. It turns out that our extended to production insurance SOE model matches well the average reserves-to-output ratio in the data for Latin America, represented by nearly half of our sample, 16 countries, at just above 10%. Yet, for Asia, Africa and Europe our regional model-based ratios understate considerably the respective data averages, suggesting the need to explore alternative modelling approaches.
... Our paper also draws on the literature on sovereign debt and international reserves (Alfaro and Kanczuk, 2009;Bianchi, Hatchondo and Martinez, 2018;Bianchi and Sosa-Padilla, 2023), which in turn builds on the workhorse sovereign default model (Eaton and Gersovitz, 1981;Aguiar and Gopinath, 2006;Arellano, 2008). Most of the literature also focuses on the case where investors are either risk-neutral or their holdings of sovereign bonds are too small to affect their marginal utility. ...
... 14 This calibration also implies that the model is consistent with Russia's positive net foreign asset position. As pointed out in Bianchi, Hatchondo and Martinez (2018) and Bianchi and Sosa-Padilla (2023), default incentives depend on the gross asset and debt position, but these are more sensitive to the latter. 15 Bai, Kim and Mihalache (2017) find that the debt duration for Russia is 6.83 years (using data for the period January 1993 -June 2009). ...
... The paper is also related to the literature of reserves management. Papers by Bianchi et al. (2018), Bianchi and Sosa-Padilla (2020) and Hur and Kondo (2016) focus on the role of foreign reserves in reducing sovereign default risk. We show both empirically and theoretically the relevance of reserves on the currency composition of sovereign debt. ...
