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

Andres Vesilind () and Toivo Kuus ()

No 2005-6, Bank of Estonia Working Papers from Bank of Estonia

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.

Keywords: trading rules; active management; central bank reserves (search for similar items in EconPapers)
JEL-codes: E44 E47 E58 F37 G11 G15 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-mac
Date: 2005-10-10, Revised 2005-10-10
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