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Foreign reserves’ strategic asset allocation

Author

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  • Carlos Léon

    ()

  • Daniel vela

    ()

Abstract

Despite foreign reserves’ strategic asset allocation relies mainly on Modern Portfolio Theory (MPT), the unique characteristics of central banks obliges them to articulate and reconcile typical optimization procedures with reserves’ management objectives such as providing confidence regarding the ability to meet the country’s external commitments. Moreover, further involvedness come from broad economic factors as diverse as the openness of capital and current accounts, external debt’s maturity and currency composition, and exchange rate regime. Therefore, in order to alleviate the divergence from theory and practice regarding foreign reserves’ strategic asset allocation, this paper describes the methodologies and procedures developed and employed by the Foreign Reserves Department of Banco de la República. The mainstay of the paper is a long-term-dependence-adjusted and non-loss-constrained version of the Black-Litterman model for obtaining the efficient frontier from a set of investments complying with safety, liquidity and return criteria, where the choice of the portfolio which maximizes utility makes use of an estimation of the Board of Directors’ risk aversion. Results exhibit the effects of the unique nature of foreign reserves management for emerging markets. Typical features of foreign reserves management by central banks, such as non-loss restrictions due to capital preservation objectives, result in increased complexity in the optimization process and in asset allocations significantly distant from standard MPT’s optimality.

Suggested Citation

  • Carlos Léon & Daniel vela, 2011. "Foreign reserves’ strategic asset allocation," Borradores de Economia 645, Banco de la Republica de Colombia.
  • Handle: RePEc:bdr:borrec:645
    DOI: 10.32468/be.645
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    File URL: https://doi.org/10.32468/be.645
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    Cited by:

    1. Mario Alejandro Acosta R., 2014. "Las acciones como activo de reserva para el Banco de la República," Documentos CEDE 011004, Universidad de los Andes - CEDE.

    More about this item

    Keywords

    Foreign reserves; Black-Litterman; strategic asset allocation.;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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