Have the Adjustment Cost and Confidence Concern Lost their Importance in Central Banks' Demand for International Reserves Function?

Abstract

Why do countries hold international reserves? We study the determinants of the demand for international reserves. First, we apply the plain Buffer Stock Model, then we add shadow exchange rate to account for the asymmetry in the change of international reserves. We find that for the monetary authorities, while opportunity cost is still a crucial issue, it is mainly the adjustment cost and confidence concern that determines the demand for international reserves. This is consistent with the risk averse behaviour of central banks.