International Reserves Management in a Model of Partial Sovereign Default

Ricardo Sabbadini

No 496, Working Papers Series from Central Bank of Brazil, Research Department

Abstract: Despite the cost imposed by the interest rate spread between sovereign debt and international reserves, emerging countries’ governments maintain stocks of both. I investigate the optimality of this joint accumulation of assets and liabilities using a quantitative model of sovereign debt, in which: i) international reserves only function to smooth consumption, before or after a default; ii) the sovereign’s decision to repudiate debt determine the spread; iii) lenders are risk-averse; and iv) default is partial. Simulated statistics from the benchmark model match their observed counterparts for average debt and spread, consumption volatility, and the main correlations among the relevant variables. Due to the presence of partial default and risk-averse lenders, the model also produces a mean reserve level of 7.7% of GDP, indicating that the optimal policy is to hold positive amounts of reserves.

Date: 2019-07
New Economics Papers: this item is included in nep-dge
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Working Paper: International Reserves Management in a Model of Partial Sovereign Default (2018)
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