Michael Devereux

Foreign reserves management changes the risk profile of a currency, there- fore influencing the pricing of sovereign debt, and the sovereign debt cur- rency portfolio. Empirically, inflation-targeters in emerging countries with higher foreign reserves feature an “original sin” dissipation: high local cur- rency share in the sovereign debt portfolio. We propose a quantitative model of optimal reserves management and sovereign currency portfolios. The op- timal reserves policy leans against the global wind so the exchange rate de- preciates less in global bad times, resulting in a lower premium charged by global investors and more local currency sovereign debt. We confirm these features empirically and via data-simulated regressions.