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A Global Safe Asset for and from Emerging Market Economies

Markus Brunnermeier () and Lunyang Huang

No 13387, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper examines international capital flows induced by flight-to-safety and proposes a new global safe asset. In the model domestic investors have to co-invest in a safe asset along with their physical capital. At times of crisis, investors replace the initially safe domestic government bonds with safe US Treasuries and fire-sell part of their capital. The reduction in physical capital lowers GDP and tax revenue, leading to increased default risk justifying the loss of the government bond's safe-asset status. We compare two ways to mitigate this self-fulfilling scenario. In the "buffer approach" international reserve holding reduces the severity of a crisis. In the "rechannelling approach'' flight-to-safety capital flows are rechannelled from international cross-border flows to flows across two EME asset classes. The two asset classes are the senior and junior bond of tranched portfolio of EME sovereign bonds.

Keywords: Capital Flows; Flight to safety; SBBS; sovereign bond backed securities; sudden stop (search for similar items in EconPapers)
JEL-codes: F32 G23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ifn and nep-opm
Date: 2018-12
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Chapter: A Global Safe Asset for and from Emerging Market Economies (2019) Downloads
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