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      Debt Redemption and Reserve Accumulation
      15 Sep 2017Working Paper Summaries

      Debt Redemption and Reserve Accumulation

      by Laura Alfaro and Fabio Kanczuk
      This study examines how reserve accumulation affects governments’ decisions to default. The analysis assumes that countries can accumulate reserves and borrow internationally using their own currency. Results suggest that the optimal level of international reserves is fairly large because their cost is mitigated by valuation-smoothing gains. The model matches some features of Brazil’s economic fluctuations.
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      Author Abstract

      In the past decade, foreign participation in local-currency bond markets in emerging countries increased dramatically. We revisit sovereign debt sustainability under the assumptions that countries can accumulate reserves and borrow internationally using their own currency. As opposed to traditional sovereign-debt models, asset-valuation effects occasioned by currency fluctuations act to absorb global shocks and render consumption smoother. Countries do not accumulate reserves to be depleted in “bad” times. Instead, issuing domestic debt while accumulating reserves acts as a hedge against external shocks. A quantitative exercise of the Brazilian economy suggests this strategy to be effective for smoothing consumption and reducing the occurrence of default.

      Paper Information

      • Full Working Paper Text
      • Working Paper Publication Date: August 2017
      • HBS Working Paper Number: HBS Working Paper #13-074
      • Faculty Unit(s): Business, Government and International Economy
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      Laura Alfaro
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