Endogenous Corporate Leverage Response to a Safer Macro Environment: The Case of Foreign Exchange Reserve Accumulation / Hui Tong, Shang-Jin Wei.

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Tong, Hui

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w26545.Publication details: Cambridge, Mass. National Bureau of Economic Research 2019.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: A country may adopt policy measures such as raising its foreign exchange reserves to better prepare for foreign interest rate shocks or sudden reversal of international capital flows, which in principle should reduce financial vulnerability for its firms and the entire economy, but the beneficial effect of such policies may be partially offset by endogenous firms' decisions to take on more risks. We present a robust but previously undocumented relationship between corporate leverage and country-level foreign exchange reserve holdings. For 6610 non-financial firms in 23 emerging markets from 2000 to 2006, we show that more foreign reserve accumulation leads to higher corporate leverage. While the reserve accumulation can reduce macroeconomic uncertainty, the increase in corporate leverage is also significantly greater in sectors that are intrinsically more sensitive to policy uncertainty. We go from correlation to causality via a two-prong instrumental variable strategy: simultaneously (1) instrumenting FX reserves by global commodity price movement, and (2) examining leverage of firms outside the commodity-sensitive sectors.

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Holdings
Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w26545 (Browse shelf(Opens below))	Not For Loan

Total holds: 0

December 2019.

A country may adopt policy measures such as raising its foreign exchange reserves to better prepare for foreign interest rate shocks or sudden reversal of international capital flows, which in principle should reduce financial vulnerability for its firms and the entire economy, but the beneficial effect of such policies may be partially offset by endogenous firms' decisions to take on more risks. We present a robust but previously undocumented relationship between corporate leverage and country-level foreign exchange reserve holdings. For 6610 non-financial firms in 23 emerging markets from 2000 to 2006, we show that more foreign reserve accumulation leads to higher corporate leverage. While the reserve accumulation can reduce macroeconomic uncertainty, the increase in corporate leverage is also significantly greater in sectors that are intrinsically more sensitive to policy uncertainty. We go from correlation to causality via a two-prong instrumental variable strategy: simultaneously (1) instrumenting FX reserves by global commodity price movement, and (2) examining leverage of firms outside the commodity-sensitive sectors.