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The sovereign property of foreign reserve investment in China: A CVaR approach

Author

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  • Li, Jie
  • Huang, Huaxia
  • Xiao, Xiao

Abstract

This paper investigates the role of foreign exchange reserve investment to hedge overall macroeconomic risks. Different from usual micro profit-maximizing purpose, the investment with macro objective is unique in the field of foreign reserve investment. We propose a framework of mean-variance-CVaR (conditional value at risk) model to capture the features of such investment and calculate the optimal allocation of foreign reserves in China. We use Cornish–Fisher method to calculate CVaR and adopt quasi-Newton algorithm to solve the optimization problem. Two scenarios are compared in the paper: the usual micro profit-maximizing portfolio and the sovereign portfolio hedging macro risks. We find that hedging the overall macro risks and lower the overall volatility of the economy through foreign reserve investment is possible under certain risk constraints.

Suggested Citation

  • Li, Jie & Huang, Huaxia & Xiao, Xiao, 2012. "The sovereign property of foreign reserve investment in China: A CVaR approach," Economic Modelling, Elsevier, vol. 29(5), pages 1524-1536.
  • Handle: RePEc:eee:ecmode:v:29:y:2012:i:5:p:1524-1536
    DOI: 10.1016/j.econmod.2012.05.012
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    References listed on IDEAS

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    1. Ricardo Caballero & Stavros Panageas, 2006. "Contingent Reserves Management: An Applied Framework," Central Banking, Analysis, and Economic Policies Book Series,in: Ricardo Caballero & César Calderón & Luis Felipe Céspedes & Norman Loayza (Series Editor) & Klaus Sc (ed.), External Vulnerability and Preventive Policies, edition 1, volume 10, chapter 12, pages 399-420 Central Bank of Chile.
    2. Diana Roman & Kenneth Darby-Dowman & Gautam Mitra, 2007. "Mean-risk models using two risk measures: a multi-objective approach," Quantitative Finance, Taylor & Francis Journals, vol. 7(4), pages 443-458.
    3. Dani Rodrik, 2006. "The social cost of foreign exchange reserves," International Economic Journal, Taylor & Francis Journals, vol. 20(3), pages 253-266.
    4. Philippe Artzner & Freddy Delbaen & Jean-Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228.
    5. Ogryczak, Wlodzimierz & Ruszczynski, Andrzej, 1999. "From stochastic dominance to mean-risk models: Semideviations as risk measures," European Journal of Operational Research, Elsevier, vol. 116(1), pages 33-50, July.
    6. Rockafellar, R. Tyrrell & Uryasev, Stanislav, 2002. "Conditional value-at-risk for general loss distributions," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1443-1471, July.
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    Citations

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    Cited by:

    1. Xu, Qifa & Zhou, Yingying & Jiang, Cuixia & Yu, Keming & Niu, Xufeng, 2016. "A large CVaR-based portfolio selection model with weight constraints," Economic Modelling, Elsevier, vol. 59(C), pages 436-447.

    More about this item

    Keywords

    Foreign reserves; Sovereign property; Conditional value at risk;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • F49 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Other
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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