A MODEL OF INTERNATIONAL RESERVE POOLING (DEVELOPMENT FINANCE, SOUTH-SOUTH, MONETARY COOPERATION, INVERSE GAUSSIAN DISTRIBUTION)

Countries hold international reserves for the same motives individuals and corporations hold cash. However, in non-oil producing developing countries the 'precautionary' motive plays a particular role in reserves decisions. This is a result of these countries' systematic negative current account balance. At the same time, holding foreign exchange in the form of reserves means foregoing income generating real investment. Thus, the careful management of reserves is required. Reserve pooling is an instrument to enhance this management.;The first order conditions obtained from a utility maximizing procedure determine the results obtained from the pooling model. This model predicts that reserve pooling is a Pareto optimal choice for the management of foreign exchange reserves for every member of a group of candidates. However, for this to hold, the pool must finance only a limited portion of members' excess demand of foreign exchange resulting from a cumulative negative current account balance. Members, in turn, will pool only a limited portion of available reserves. The decision on the total level of reserves to be managed by the pool and the weight of participating shares can be made independently. The model also provides an algorithm to compute the optimal solution of participating shares.;This study attempts to develop rigorously the theoretical foundations of the reserve pool. To develop the structure of the model the current account balance of non-oil developing countries is assumed to follow a Wiener process with a negative drift. The stochastic time, called the 'hitting time', it takes for a cumulative balance to exhaust a given initial level of reserves is assumed to be the argument for the monetary authorities' utility function. Thus the decision on the management form and size of reserves can be made based on the mean and variance of this hitting time.