Optimal level of reserve holding: an empirical investigation in the case of Albania

Shijaku, Gerti (2012): Optimal level of reserve holding: an empirical investigation in the case of Albania. Published in:

Abstract

This discussion material analyses the change in international reserve holdings and their determinants, and evaluates their optimal level from a cost opportunity perspective. The material is based on the Buffer Stock model. This model assumes that reserve holdings are affected by changes of payments and receipts in the balance of payments. Reserves serve as a buffer stock to accommodate fluctuations of external transactions. The focus of the model is to estimate the optimal level of reserves against possible exogenous shocks or a crisis, particularly fluctuations of foreign capital inflows, mainly remittances. The volatility of reserve holdings is generated by Autoregressive Conditional Heteroskedasticity (ARCH) estimation, while the Buffer Stock model is estimated with an ARDL approach. Results indicate a negative relationship of reserve holdings with opportunity cost, volatility and deviation of exchange rate from the trend and positive relationship with imports. The approach estimation suggests that the level of optimal reserve holdings is more sensitive to precautionary rather than mercantilist motives.

• Item Type: MPRA Paper
• Language: English
• Keywords: International Reserve Holdings, Buffer Stock Model, EGARCH(p,q)-AR(q), ARDL Approach
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics

References

Aizenman, J., and Lee, J., (2005), “International reserves: precautionary vs. mercantilist views, theory and evidence”, IMF Working Paper, WP/05/198;

Aizenman, J., and Nancy, M., (2004), “International reserve holdings with sovereign risk and costly tax collection”, The Economic Journal, Blackwell Publishing, Vol. 114, No. 497 (Jul., 2004), pp. 569-591;

Aizenman, J., and Nancy, M., (2003), “The high demand for international reserves in the far east: what is going on?”, Journal of the Japanese and International Economies 17(3), pp: 370-400;

Aizenman, and Sun, J., (2009), “The financial crisis and sizable international reserves depletion: from ‘fear of floating’ to the ‘fear of losing international reserves’?”, NBER Paper, working Paper 15308, Cambridge;

Badinager, H., (2004), “Austria’s demand for international reserves and monetary disequilibrium: the case of a small open economy with a fixed exchange rate regime”, Economica, Vol. 71, pp: 39-55;

Bahani-Oskooee, M., and Rehman, H. J., (2005), “Stability of money demand function in Asian developing countries”, Applied Economics, pp: 773-792;

Bahmani-Oskooee, M., (2004), “Kalmna filter approach to estimating the demand for international reserves”, Applied Economics, Vol. 34, pp: 1665-1668;

Bahmani-Oskooee, M., (1999), “Are the adjustment of actual to desired international reserves in nominal or real terms?”, Applied Economics Letters, Vol. 6, pp: 573 – 575;

Ben-Bassat, A., and Gottlieb, D., (1992), “On the effect of opportunity cost on international reserve holdings”, The Review of Economics and Statistics, The MIT Press, Vol. 74, No. 2, pp. 329-332;

Brookes, C., et. al., (2003), “Multivariete GARCH models: software choice and estimation issues”, ISMA Centre Discussion Papers in Finance 2003–07;

Brown, R. L., et al, (1975), “Techniques for testing the consistency of regression of relationships overtime”, Journal of Royal Statistical Society, Vol. 37, pp: 149-163;

Bussiere, M., and Mulder, C., (1999), “External vulnerability in emerging market econimies: how high liquity can offset weak fundamentals and the effects of contagion”, IMF working Paper, WP/99/88;

Calvo, G. A., (1998), “Capital flows and capital – market crisis: the simple economics of sudden stops”, Journal of Applied Economics, Vol: 1 no. 1, pp: 35-54;

Clark, P. B., (1970), “Optimal international reserves and speed of adjustment”, Journal of Political Economy”, Vol. 78, No. 2 (Mar – Apr 1970), pp: 356-376;

Clark, P. B., (1974), “Demand for international reserves: a cross-country analysis, Canadian Journal of Economics”, Nr 3, pp: 356-376;

Dickey, D. A., and Fuller, w. A., (1981), “Likehood ratio statistics for autoregressive times series with a Unit Root”, Econometrica, Vol. 49, pp: 1057-1072;

Edwards, S., (1985), “On the interest-rate elasticity of the demand for international reserves: some evidence from developing countries”, Department of Economics, University of California, National Bureau of Economic Research, working Paper No. 1532;

Edwards, S. (1984), “The demand for internacional reserves and monetary equilibrium: some evidence from developing countries”, The Review of Economics and Statistics, Vol. 66, No. 3, pp: 495-500;

Edwards, S., (1983), “The demand for international reserves and exchange rate adjustments: the case of LDCs 1964-1972”, Blackwell Publishing Economica, New Series, Vol. 50, No. 199, pp: 269-280;

Elbadawi, A. I., (1990), “The sudan demand for international reserve: a case of a labour-exporting country”, Economica, New Series, Vol. 57, No. 225, pp: 73-89;

Enders, W., (2010), “Modelling volatility”, in applied econometric time series”, Wiley, USA, 3rd Edition, Chapter 3, pp: 121-176;

Engle, R. F., and Granger, C. J. L., (1987), “Cointegration and error correction representation: estimation and testing”, Econometrica, Vol: 55, pp: 251-276;

Feldstein, M. (1999), “A self-help guide for emerging markets”, Foreign Affairs, Vol. 78, No. 2, pp: 93-109;

Flood, R., and Nancy, M., (2002), “Holding international reserves in an era of high capital mobility”, IMF working Paper, WP/02/62;

Frenkel, J., and Jovanovic, B., (1981), “Optimal international reserves: a stochastic framework”, Economic Journal, Vol: 91 (June), pp: 507-514;

Granger, C. w. J., (1986), “Development in the study of cointegrated economic variables”, Oxford Bulletin of Economic and Statistics, Vol 48, pp: 213-228;

Heller, H. R. (1966), “Optimal international reserves”, Economic Journal 76(302), pp: 296-311;

Heynen, R. C., and Kat, H. M., (1994), “Volatility prediction: a comparison of stochastic volatility, GARCH(1,1) and EGARCH(1,1) models”, Journal of Derivates, Vol. 2, No. 2, pp: 50-65;

International Monetary Fund, (2000), “Annual report”, Washington, D.C.;

Johansen, S., (1995), “Likehood-based inference in cointegrated vector autoregressive models”, Oxford University Press, Oxford;

Johansen, S,. (1992), “Cointegration in partial systems and the efficiency of single-equation analysis”, Journal of Econometrics, Vol. 52, pp: 389-402;

Johansen, S., (1991), “Estimation and hypothesis testing of cointegration vectors in gaussian vector autoregressive models”, Econometrica, Vol. 59, pp: 1551-1580;

Narayan, P. K., (2004), “Reformulating critical values for the bounds F-statistics approach to cointegration: an application to the tourism demand model for Fiji”, Monash University, Australia, No. 02/04;

Pesaran, M. H., et al, (2001), “Bound testing approaches to the analysis of level of relationships”, Journal of Applied Econometrics, chapter 16, pp: 289-326;

Philips, P. C. B., dhe Perron, P., (1988), “Testing for a unit root in time series regression”, Biometrika, Vol. 65, pp: 335-46;

Prabheesh, K P, Malathy, D., and Madhumathi, R., (2007), “Demand for foreign exchange reserves in India: a co-integration approach”, MPRA, Youth Asian Journal of Management Vol. 14, No. 2 2007, 36 – 46;

Prabheesh, K P, Malathy, D., and Madhumathi, R., (2009). “Precautionary and mercantilist approaches to demand for international reserves: an empirical investigation in the Indian context”, Macroeconomics and Finance in Emerging Market Economies, Vol. 2, No. 2, September 2009, pp: 279-291;

Ramachandran, M. (2006), “On the upsurge of foreign exchange reserves in India”, Journal of Policy Modeling, Vol. 28, pp: 797-809;

Ramachandran, M., (2004), “The optimal level of international reserves: evidence for India”, Economics Letter, Vol: 83, pp: 347-370;

Rummel, O., (2010), “Modelling pound sterling exchange rate volatility”, Centre for Central Banking Studies, Bank of England, 8 December 2010;

Silva, A. F. J., and Silva, da, E. D., (2004), “Optimal international reserves holdings in emerging markets economies: the Brazilian case”, Banco Central do Brazil;

Slaman, F., dhe Salih, A., (1999), “Modelling the volatility in the Central Bank Reserves”, Research Paper of Central Bank of Turkey;

Vika, I., and Luçi, E., (2009), “The equilibrium real exchange rate of Lek vis-à-vis Euro: is it much misaligned?”, Discussion Paper (Draft Material), Bank of Albania;

Vika, I., (2008), “Assessing motives behind the Bank of Albania’s purchase interventions in the foreign exchange market”, Research Department, Bank of Albania, November 2008;

Wijnholds, J. O. de B., and Kapteyn, A., (2001), “Reserve adequacy in emerging market economies”, IMF Working Paper, WP/01/143;