International Reserves for Emerging Economies: A Liquidity Approach

47 Pages Posted: 26 May 2016

See all articles by Kuk Mo Jung

Kuk Mo Jung

Henan University

Ju Hyun Pyun

Korea University Business School (KUBS)

Date Written: May 25, 2016

Abstract

The massive stocks of foreign exchange reserves, mostly held in the form of U.S. T-bonds by emerging economies, are still an important puzzle. Why do emerging economies continue to willingly loan to the United States despite the low rates of return? We suggest that a dynamic general equilibrium model incorporating international capital markets, characterized by decentralized trade and U.S. T-bonds as facilitators of trade, can provide one possible resolution to this question. Declining financial frictions in these over-the-counter (OTC) markets would generate rising liquidity premium on U.S. T-bonds, thereby causing low U.S real interest rates. Meanwhile, the superior liquidity properties of the U.S. T-bonds would induce recipients of foreign investments, namely emerging economies, to hold more liquidity, that is U.S. T-bonds, in equilibrium. The prediction of our model is confirmed by an empirical simultaneous equations approach considering an endogenous relationship between OTC capital inflows and reserve holdings.

Keywords: international reserves, over-the-counter markets, liquidity, simultaneous equations

JEL Classification: E44, E58, F21, F31, F36, F41

Suggested Citation

Jung, Kuk Mo and Pyun, Ju Hyun, International Reserves for Emerging Economies: A Liquidity Approach (May 25, 2016). Available at SSRN: https://ssrn.com/abstract=2784112 or http://dx.doi.org/10.2139/ssrn.2784112

Kuk Mo Jung (Contact Author)

Henan University ( email )

85 Minglun St. Shunhe
Kaifeng, CA Henan 475001
China

Ju Hyun Pyun

Korea University Business School (KUBS) ( email )

145 Anam-Ro, Seongbuk-Gu
Seoul, 02841
Korea, Republic of (South Korea)
82-2-3290-2610 (Phone)

HOME PAGE: http://sites.google.com/site/juhyunpyun/research

Register to save articles to
your library

Register

Paper statistics

Downloads
26
Abstract Views
296
PlumX Metrics