Foreign reserves management subject to a policy objective

Joachim Coche, Ken Nyholm, Matti Koivu and Vesa Poikonen

No 624, Working Paper Series from European Central Bank

Abstract: This paper studies the implications of introducing an explicit policy objective to the management of foreign reserves at a central bank. A dynamic model is developed which links together reserves management and the exchange rate by foreign exchange interventions. The exchange rate is modelled as a mean-reverting autoregressive process incorporating a linear response to interventions. The premise is that it is the objective of the central bank to prevent undervaluation of its currency. Given this objective, the model is formulated in a one- and a multi-period setting and solved to find the optimal asset allocation. The results show that asset allocation can significantly help in achieving the desired policy objective. JEL Classification: G11, F31

Keywords: exchange rate modelling; foreign exchange intervention; Foreign reserves management; optimal asset allocation (search for similar items in EconPapers)
Date: 2006-05
Note: 443962
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:2006624

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