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Optimal reserve composition in the presence of sudden stops

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  • Beck, Roland
  • Rahbari, Ebrahim

Abstract

We analytically derive optimal central bank portfolios in a minimum variance framework with two assets and transaction demands caused by sudden stops in capital inflows. In this model, transaction demands become less important relative to traditional portfolio objectives as debt to reserve ratios decrease. We empirically estimate optimal dollar and euro shares for 23 emerging market countries and find that optimal reserve portfolios are dominated by anchor currencies and, at current debt-to-reserve ratios, introducing transaction demand has a relatively modest effect for most countries. We find that, in general, the dollar acts as a safe haven currency during sudden stops for country specific and global sudden stops, increasing the optimal share of dollar bonds in central bank portfolios. Correspondingly, our model predicts that dollar shares should decline as debt-to-reserve ratios fall, as observed in recent data. We also find that the denomination of foreign currency debt has little importance for optimal reserve portfolios.

Suggested Citation

  • Beck, Roland & Rahbari, Ebrahim, 2011. "Optimal reserve composition in the presence of sudden stops," Journal of International Money and Finance, Elsevier, vol. 30(6), pages 1107-1127, October.
  • Handle: RePEc:eee:jimfin:v:30:y:2011:i:6:p:1107-1127
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    References listed on IDEAS

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    Cited by:

    1. Roland Beck & Sebastian Weber, 2011. "Should Larger Reserve Holdings Be More Diversified?," International Finance, Wiley Blackwell, vol. 14(3), pages 415-444, December.
    2. Franziska L Ohnsorge & Marcin Wolski & Yuanyan S Zhang, 2014. "Safe Havens, Feedback Loops, and Shock Propagation in Global Asset Prices," IMF Working Papers 14/81, International Monetary Fund.
    3. Édouard Vidon, 2009. "Monnaies de réserve et stabilité financière internationale," Revue d'Économie Financière, Programme National Persée, vol. 94(1), pages 219-232.
    4. repec:eee:jeborg:v:142:y:2017:i:c:p:140-163 is not listed on IDEAS
    5. Fabio Bertoni & Stefano Lugo, 2013. "Testing the Strategic Asset Allocation of Stabilization Sovereign Wealth Funds," International Finance, Wiley Blackwell, vol. 16(1), pages 95-119, February.
    6. Marie Brière & Valérie Mignon & Kim Oosterlinck & Ariane Szafarz, 2016. "Towards greater diversification in central bank reserves," Journal of Asset Management, Palgrave Macmillan, vol. 17(4), pages 295-312, July.
    7. Beckmann, Joscha & Czudaj, Robert, 2017. "Capital flows and GDP in emerging economies and the role of global spillovers," Journal of Economic Behavior & Organization, Elsevier, vol. 142(C), pages 140-163.
    8. repec:dau:papers:123456789/7874 is not listed on IDEAS
    9. repec:eee:quaeco:v:65:y:2017:i:c:p:304-313 is not listed on IDEAS
    10. Kathryn M.E. Dominguez & Rasmus Fatum & Pavel Vacek, 2013. "Do Sales of Foreign Exchange Reserves Lead to Currency Appreciation?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(5), pages 867-890, August.
    11. Hasan Comert & Mehmet Selman Colak, 2014. "Can Financial Stability be Maintained in Developing Countries after the Global Crisis: The Role of External Financial Shocks?," ERC Working Papers 1411, ERC - Economic Research Center, Middle East Technical University, revised Jan 2015.
    12. repec:eee:jimfin:v:74:y:2017:i:c:p:371-385 is not listed on IDEAS
    13. Habib, Maurizio Michael & Stráský, Jan, 2008. "Oil exporters: in search of an external anchor," Working Paper Series 958, European Central Bank.
    14. Karel Brůna, 2010. "Akumulace devizových rezerv centrálních bank a dynamika absorpce likvidity bankovních systémů České republiky, Polska a Maďarska
      [Central Bank´s Foreign Exchange Reserves Accumulation and Dynamics
      ," Politická ekonomie, University of Economics, Prague, vol. 2010(6), pages 723-746.
    15. Kumar, Satish, 2016. "Evidence of information transmission across currency futures markets using frequency domain tests," The North American Journal of Economics and Finance, Elsevier, vol. 37(C), pages 319-327.
    16. Frank Moss, 2011. "The euro: internationalised at birth," BIS Papers chapters,in: Bank for International Settlements (ed.), Currency internationalisation: lessons from the global financial crisis and prospects for the future in Asia and the Pacific, volume 61, pages 57-74 Bank for International Settlements.
    17. Hermann Remsperger & Adalbert Winkler, 2009. "Welchen Einfluss hat der Wechselkurs auf die internationale Rolle von US-Dollar und Euro?," Perspektiven der Wirtschaftspolitik, Verein für Socialpolitik, vol. 10(1), pages 21-38, February.
    18. Norman C. Miller, 2014. "Exchange Rate Economics," Books, Edward Elgar Publishing, number 14981.
    19. Andrew Sheng, 2012. "Opening remarks," BIS Papers chapters,in: Bank for International Settlements (ed.), Financial sector regulation for growth, equity and stability, volume 62, pages 41-44 Bank for International Settlements.
    20. repec:mcb:jmoncb:v:45:y:2013:i::p:867-890 is not listed on IDEAS
    21. Zhang, Bin, 2011. "Is It Desirable for Asian Economies to Hold More Asian Assets in Their Foreign Exchange Reserves?—The People’s Republic of China’s Answer," ADBI Working Papers 306, Asian Development Bank Institute.

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