A Global Equilibrium Model of Sudden Stops and External Liquidity Management
Ricardo J. Caballero
Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
September 7, 2007
MIT Department of Economics Working Paper No. 08-05
Emerging market economies, which have much of their growth ahead of them, either run or should run persistent current account deficits in order to smooth consumption intertemporally. The counterpart of these deficits is their dependence on capital inflows, which can suddenly stop. We make two contributions in this paper: First, we develop a quantitative global-equilibrium model of sudden stops. Second, we use this structure to discuss practical mechanisms to insure emerging markets against sudden stops, ranging from conventional non-contingent reserves accumulation to more sophisticated contingent instrument strategies. Depending on the source of sudden stops, their correlation with world events, and the quality of the hedging instrument available, the gains from these strategies can represent a substantial improvement over existing practices.
Number of Pages in PDF File: 54
Keywords: Capital flows, sudden stops, reserves, international liquidity management, world, capital markets, swaps, insurance, hedging, options, hidden states, Bayesian methods
JEL Classification: E2, E3, F3, F4, G0, C1
Date posted: March 20, 2008
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