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Asset Class Diversification and Delegation of Responsibilities between Central Banks and Sovereign Wealth Funds

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  • Aizenman, Joshua
  • Glick, Reuven

Abstract

This paper presents a model comparing the optimal degree of asset class diversification abroadby a central bank and a sovereign wealth fund. We show that if the central bank manages itsforeign asset holdings in order to meet balance of payments needs, particularly in reducing theprobability of sudden stops in foreign capital inflows, it will place a high weight on holding saferforeign assets. In contrast, if the sovereign wealth fund, acting on behalf of the Treasury,maximizes the expected utility of a representative domestic agent, it will opt for relativelygreater holding of more risky foreign assets. We also show how the diversification differencesbetween the strategies of the bank and SWF is affected by the government’s delegation ofresponsibilities and by various parameters of the economy, such as the volatility of equity returnsand the total amount of public foreign assets available for management.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt5ps238ph.

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Date of creation: 15 Sep 2010
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Handle: RePEc:cdl:ucscec:qt5ps238ph

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Keywords: Social and Behavioral Sciences; Sovereign wealth funds; capital flows; foreign exchange reserves; financial markets; governance;

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  1. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 100(4), pages 1169-89, November.
  2. Joshua Aizenman & Jaewoo Lee, 2005. "International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence," NBER Working Papers, National Bureau of Economic Research, Inc 11366, National Bureau of Economic Research, Inc.
  3. Joshua Aizenman & Reuven Glick, 2008. "Sovereign wealth funds: stylized facts about their determinants and governance," Working Paper Series, Federal Reserve Bank of San Francisco 2008-33, Federal Reserve Bank of San Francisco.
  4. Edwin M. Truman, 2008. "A Blueprint for Sovereign Wealth Fund Best Practices," Policy Briefs, Peterson Institute for International Economics PB08-3, Peterson Institute for International Economics.
  5. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, Elsevier, vol. 40(3-5), pages 1037-1047, April.
  6. Joshua Aizenman & Reuven Glick, 2005. "Pegged exchange rate regimes -- a trap?," Working Paper Series, Federal Reserve Bank of San Francisco 2006-07, Federal Reserve Bank of San Francisco.
  7. Aizenman, Joshua & Marion, Nancy P., 2003. "International Reserve Holdings with Sovereign Risk and Costly Tax Collection," Santa Cruz Center for International Economics, Working Paper Series, Center for International Economics, UC Santa Cruz qt9s7978n1, Center for International Economics, UC Santa Cruz.
  8. Olivier Jeanne, 2007. "International Reserves in Emerging Market Countries: Too Much of a Good Thing?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 1-80.
  9. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, American Economic Association, vol. 85(1), pages 150-67, March.
  10. Joshua Aizenman & Reuven Glick, 2007. "Sovereign wealth funds: stumbling blocks or stepping stones to financial globalization?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue dec14.
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