The Empirical Analysis Of Structural Configuration Of Optimal Foreign Exchange Currency

We consider recent issues in China’s foreign exchange reserve managementsprouting from sterilization costs and losses incurred from the2008global financialcrisis and begin by splitting the foreign exchange reserve portfolio into basic andexcess investment tranches，as per previous literature’s suggestions.Then，we set transaction demands as the basis for the basic foreign exchangereserve investment tranche. We use imports， foreign debt and foreign directinvestment remittances as restrictions for the optimal currency composition，and，assuming the Swiss Franc as a risk-free asset，employ a Dynamic ConditionalCorrelation General Auto Regressive Conditional Heteroscedacticity model toestimate currency composition volatility in2005-2010for the U.S. Dollar，as well asthe transaction-cost-adjusted Euro， Japanese Yen and English Pound as riskycurrencies.We found that during this period，the Euro，due to its decreasing transaction costsand increasing profitability，deserves a greater share in Chinese reserves. Conversely，the Dollar’s share becomes smaller in the reserves due to the global financial crisisand worry for future U.S. inflation. Transaction demands brought forth by theJapanese Yen decrease the basic tranche’s overall profitability，thus possibly requiringmanagers of the excess tranche to pursuit a higher rate of profitability to preventlosses in the overall foreign exchange reserve.Furthermore， we found that using the mean-variance approach in foreignexchange reserve management to guarantee profit remittances by foreign directinvestors comes at a small cost；we thus recommend using reserves for this purpose.This is this thesis’ greatest contribution to the research surrounding China’s foreignexchange reserve management.