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Application of investment models in foreign exchange reserve management in Eesti Pank

Author

Listed:
  • Andres Vesilind

    ()

  • Toivo Kuus

    ()

Abstract

This paper describes active investment strategy used in the central bank of Estonia and introduces model-based investment decisions as a component of that strategy. The first chapter of the paper describes the evolution of the investment process in Eesti Pank and outlines the framework of reserve management. It describes the role of several forms and styles of investing: active and passive management, qualitative and quantitative management, emphasizing the role of diversification for achieving better performance. The chapter concludes with the description of the investment strategy used in the central bank of Estonia. The second chapter describes model-based investing as part of active management strategy. Three investment models are estimated and tested: a model for directional positions in the US, German and Japanese 10-year government bond futures, a model for cross-currency positions in ten major currencies, and a model for cross-country yield spread trades in eight major government bond markets. The models extend the framework developed by Ilmanen and Sayood (Ilmanen et al. 2002). After the model estimation the models are combined with a trend-following model and the whole set of diversified models is tested. Finally, correlation study of these results with the results of external asset managers and in-bank discretionary analysis is performed. The paper ends with a discussion on the possibilities for further development of the quantitative investment program and conclusions.

Suggested Citation

  • Andres Vesilind & Toivo Kuus, 2005. "Application of investment models in foreign exchange reserve management in Eesti Pank," Bank of Estonia Working Papers 2005-6, Bank of Estonia, revised 10 Oct 2005.
  • Handle: RePEc:eea:boewps:wp2005-06
    as

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    File URL: http://www.eestipank.ee/sites/eestipank.ee/files/publication/en/WorkingPapers/2005/_wp_605.pdf
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    References listed on IDEAS

    as
    1. Frankel, Jeffrey A. & Rose, Andrew K., 1995. "Empirical research on nominal exchange rates," Handbook of International Economics,in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 33, pages 1689-1729 Elsevier.
    2. Diebold, Francis X. & Li, Canlin, 2006. "Forecasting the term structure of government bond yields," Journal of Econometrics, Elsevier, vol. 130(2), pages 337-364, February.
    3. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
    4. Greer, Mark, 2003. "Directional accuracy tests of long-term interest rate forecasts," International Journal of Forecasting, Elsevier, vol. 19(2), pages 291-298.
    5. Fong, Wai Mun & Yong, Lawrence H. M., 2005. "Chasing trends: recursive moving average trading rules and internet stocks," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 43-76, January.
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    Citations

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    Cited by:

    1. Francesco Potente & Antonio Scalia, 2016. "Market timing and performance attribution in the ECB reserve management framework," Temi di discussione (Economic working papers) 1062, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    trading rules; active management; central bank reserves;

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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