The Buffer Stock Model Redux? An Analysis of the Dynamics of Foreign Reserve Accumulation

Collana Ricerche Economics Department Working Paper

29 Pages Posted: 27 Feb 2007

See all articles by Giulio Cifarelli

Giulio Cifarelli

DISEI University of Florence

Giovanna Paladino

IntesaSanpaolo; LUISS Economics Department

Date Written: February 2007


Emerging market economies have recently accumulated large stocks of foreign reserves. In this paper we address the question of what are the main factors explaining reserve holdings in nine developing countries located in Asia and Latin America. Monthly data from January 1985 to May 2006 are used to estimate for each country the long run equilibrium reserve demand, based on the buffer stock model, the short run dynamics governing the process of reserve accumulation (decumulation) and the factors which may influence the speed of adjustment of actual to desired reserves. Cointegration analysis suggests that the buffer stock precautionary model explains the optimal reserve demand reasonably well. The corresponding VECMs are further interpolated, using the permanent and transitory innovations decomposition procedure of Gonzalo and Ng (2001), in order to assess the relative impact of the time series to the convergence to equilibrium after a shock. Finally the (asymmetric) effect on the speed of convergence of positive/negative changes in signal variables - such as the excess reserves of the previous period, relative competitiveness and US monetary stance - is found to be significant, in ine with mercantilistic and fear of floating motives to hoard international reserves.

Keywords: Emerging markets reserves, cointegration, P-T components decomposition, asymmetric adjustment

JEL Classification: E56, F32, G15, C32

Suggested Citation

Cifarelli, Giulio and Paladino, Giovanna, The Buffer Stock Model Redux? An Analysis of the Dynamics of Foreign Reserve Accumulation (February 2007). Available at SSRN: or

Giulio Cifarelli

DISEI University of Florence ( email )

via delle Pandette 9
Florence 50127

Giovanna Paladino (Contact Author)

IntesaSanpaolo ( email )

Piazza San Carlo
Torino, 10121

LUISS Economics Department ( email )

Viale di Villa Massimo, 57
Rome, 00161

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