Foreign reserves´ strategic asset allocation

Carlos León and Daniel Vela ()

No 8186, Borradores de Economia from Banco de la Republica

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.

Keywords: Foreign reserves; Black-Litterman; strategic asset allocation. (search for similar items in EconPapers)
JEL-codes: C11 C61 E58 G11 (search for similar items in EconPapers)
Pages: 26
Date: 2011-03-16
New Economics Papers: this item is included in nep-ifn
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Foreign reserves’ strategic asset allocation (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:col:000094:008186

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