Optimal Reserve Management and Sovereign Debt
37 Pages Posted: 3 Jul 2007 Last revised: 13 Aug 2022
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Optimal Reserve Management and Sovereign Debt
Date Written: July 2007
Abstract
To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model that incorporates willingness-to-pay incentive problems. In this setup, debt and assets are not perfect substitutes, as reserves can be used even after a country has defaulted. We calibrate the model to a sample of emerging markets. We obtain that the reserve accumulation does not play a quantitatively important role in this model. In fact, the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.
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