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The portfolio balance effect and reserve diversification: an empirical analysis

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  • Costas Karfakis

Abstract

The purpose of this study is to examine whether the portfolio balance effect, operating through the outstanding debts of US and euro area, and the signaling effect of sterilized intervention, operating through the relative composition of official reserves of developing and emerging countries, explain the developments of the euro/dollar exchange rate. The empirical analysis reveals that both effects are statistically significant and have the correct signs. The Clark-West testing procedure indicates that the model which relates the exchange rate to official reserves and the interest rate differential outperforms the random walk model in the forecasting accuracy.

Suggested Citation

  • Costas Karfakis, 2010. "The portfolio balance effect and reserve diversification: an empirical analysis," European Economy - Economic Papers 2008 - 2015 431, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    • Handle: RePEc:euf:ecopap:0431
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