International Reserves for Emerging Economies: A Liquidity Approach

Kuk Mo Jung and Ju Hyun Pyun

MPRA Paper from University Library of Munich, Germany

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 propose that a dynamic general equilibrium model incorporating international capital markets, characterized by a non-centralized trading mechanism and U.S. T-Bonds as facilitators of trade, can provide an answer to this question. Declining financial frictions in these over-the-counter (OTC) markets would generate rising liquidity premiums on U.S. T-Bonds. Meanwhile, the higher 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 reserves holdings.

Keywords: international reserves; over-the-counter markets; liquidity; simultaneous equations (search for similar items in EconPapers)
JEL-codes: E44 E58 F21 F31 F36 F41 (search for similar items in EconPapers)
Date: 2015-05
New Economics Papers: this item is included in nep-dge, nep-ifn, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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https://mpra.ub.uni-muenchen.de/71353/1/MPRA_paper_64235.pdf revised version (application/pdf)

Related works:
Journal Article: International reserves for emerging economies: A liquidity approach (2016)
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