A Theory of Rollover Risk, Sudden Stops, and Foreign Reserves

62 Pages Posted: 3 Apr 2013 Last revised: 14 Jan 2015

See all articles by Sewon Hur

Sewon Hur

Federal Reserve Bank of Cleveland

Illenin Kondo

University of Notre Dame

Date Written: October 27, 2014

Abstract

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.

Keywords: rollover risk, reserves, sudden stops

JEL Classification: F42, F34, H63

Suggested Citation

Hur, Sewon and Kondo, Illenin, A Theory of Rollover Risk, Sudden Stops, and Foreign Reserves (October 27, 2014). FRB International Finance Discussion Paper No. 1073. Available at SSRN: https://ssrn.com/abstract=2243568 or http://dx.doi.org/10.2139/ssrn.2243568

Sewon Hur

Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Illenin Kondo (Contact Author)

University of Notre Dame

361 Mendoza College of Business
Notre Dame, IN 46556-5646
United States

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