Contingent Reserves Management: An Applied Framework
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 9, 2004
MIT Department of Economics Working Paper No. 04-32
One of the most serious problems that a central bank in an emerging market economy can face, is the sudden reversal of capital inflows. Hoarding international reserves can be used to smooth the impact of such reversals, but these reserves are seldom sufficient and always expensive to hold. In this paper we argue that adding richer hedging instruments to the portfolios held by central banks can significantly improve the efficiency of the anti-sudden stop mechanism. We illustrate this point with a simple quantitative hedging model, where optimally used options and futures on the S&P100's implied volatility index (VIX), increases the expected reserves available during sudden stops by as much as 40 percent.
Number of Pages in PDF File: 26
Keywords: Sudden stops, reserves, portfolio, VIX, hedging, options, futures.
JEL Classification: E2, E3, F3, F4, G0, C1
Date posted: September 24, 2004