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Domestic financial instability and foreign reserves accumulation in China
Author(s) -
Wang Lirong,
Hueng Chiayang James
Publication year - 2018
Publication title -
international finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.458
H-Index - 39
eISSN - 1468-2362
pISSN - 1367-0271
DOI - 10.1111/infi.12338
Subject(s) - china , economics , proxy (statistics) , foreign exchange reserves , financial market , monetary economics , capital flight , currency , financial crisis , index (typography) , capital account , incentive , international economics , finance , macroeconomics , market economy , machine learning , world wide web , computer science , political science , law
Using a time series analysis, this paper argues that domestic financial instability, which increases the potential for resident‐based capital flight from the domestic currency, provides an incentive for China to hold more foreign reserves in the short run. To measure its domestic financial conditions, we construct a monthly Chinese financial stress index, which is used as a proxy for the possibility of capital flight. The empirical results show that this index is a significant determinant of the movements of China's foreign reserves around its trend and that using M2 as a proxy for domestic financial instability as suggested by previous studies is not a valid strategy for China. It is suggested that greater attention should be given to the role of domestic financial conditions in explaining China's short‐run demand for foreign reserves.