 International reserves for emerging economies: A liquidity approachJournal of International Money and Finance, 2016, vol. 68, issue C, 230-257 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 (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:68:y:2016:i:c:p:230-257 DOI: 10.1016/j.jimonfin.2016.06.020 Access Statistics for this article Journal of International Money and Finance is currently edited by J. R. Lothian More articles in Journal of International Money and Finance from Elsevier |
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