A Tractable Model of Precautionary Reserves, Net Foreign Assets, or Sovereign Wealth Funds
We model the motives for residents of a country to hold foreign assets, including the precautionary motive that has been omitted from much previous literature as intractable. Our model captures many of the principal insights from the existing specialized literature on the precautionary motive, deriving a convenient formula for the economy's target value of assets. The target is the level of assets that balances impatience, prudence, risk, intertemporal substitution, and the rate of return. We use the model to shed light on two topical questions: The "upstream'' flows of capital from developing countries to advanced countries, and the long-run impact of resorbing global financial imbalances.
We thank Romain Ranciere for an insightful discussion of the paper at the 2009 ASSA meetings, and seminar participants at George Washington University, the Federal Reserve Bank of San Francisco, and the Bank of Canada for their comments, Patrick Toche for comments on an earlier draft, and Matthew White for excellent research assistance. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.