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Accumulation of large foreign reserves in China: a behavioural perspective

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  • Zhichao Zhang
  • Frankie Chau
  • Li Xie

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Abstract

The massive accumulation of foreign reserves by China has challenged the conventional thinking about prudent reserve management. This paper develops a behavioural model of optimal decision making under uncertainty to explain the observed Chinese reserve policy. Departing from the conventional approach to utility maximisation based on the agent’s rationality, this paper explicitly models the behaviour of Chinese central banker who is influenced by loss aversion and narrow framing. Embedding the cognitive biases into the precautionary savings approach to holding reserves, the paper shows the behavioural optimality of Chinese reserve build-up and provides a plausible explanation of the dynamics of reserve accumulation in China, hence help make sense of the puzzling Chinese reserve policy. Copyright Springer Science+Business Media New York 2013

Suggested Citation

  • Zhichao Zhang & Frankie Chau & Li Xie, 2013. "Accumulation of large foreign reserves in China: a behavioural perspective," Economic Change and Restructuring, Springer, vol. 46(1), pages 85-108, March.
  • Handle: RePEc:kap:ecopln:v:46:y:2013:i:1:p:85-108
    DOI: 10.1007/s10644-012-9136-1
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    References listed on IDEAS

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    More about this item

    Keywords

    Reserve accumulation; Precautionary savings; Behavioural finance; Loss aversion; Narrow framing; C61; F31; F43; G02;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles

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