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

Listed author(s):
  • Li, Jie
  • Huang, Huaxia
  • Xiao, Xiao
Registered author(s):

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.

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File URL: http://www.sciencedirect.com/science/article/pii/S0264999312001319
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Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 29 (2012)
Issue (Month): 5 ()
Pages: 1524-1536

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Handle: RePEc:eee:ecmode:v:29:y:2012:i:5:p:1524-1536
DOI: 10.1016/j.econmod.2012.05.012
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30411

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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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