Abstract
One of the most important objectives of holding foreign reserves is to cope with a balance of payments crisis. The liquidity required during periods of crisis defines the potential liabilities of a foreign reserves portfolio. This chapter proposes an asset allocation approach that takes into account a country’s foreign liabilities and its volatility. A reserve adequacy measure allows an estimation of the liabilities. The portfolio is divided into two tranches: an asset-liability tranche and a long-term investment tranche. For the asset-liability tranche, benchmark construction attempts to hedge the liabilities of foreign reserves. For the long-term investment tranche, asset-only optimization allows the construction of a portfolio with the objective of maximizing returns. We propose a framework for Colombia but that is applicable to any other country.
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Notes
- 1.
A Liquidity at Risk rule takes into account the foreseeable risks that a country can face. This approach requires that a country’s foreign exchange liquidity requirement can be calculated under a range of possible outcomes for relevant financial variables such as exchange rates, commodity prices, credit spreads.
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Appendix: Selected Factors from Wilshire’s Axiom Used to Explain Reserves Liabilities
Appendix: Selected Factors from Wilshire’s Axiom Used to Explain Reserves Liabilities
Factor | Country |
|---|---|
Duration | United States |
Europe | |
United Kingdom | |
Switzerland | |
Sweden | |
Canada | |
Japan | |
Australia | |
New Zealand | |
Norway | |
Emerging Markets Investment Grade | |
Currency | Europe |
United Kingdom | |
Switzerland | |
Sweden | |
Canada | |
Japan | |
Australia | |
New Zealand | |
Norway | |
Inflation | United States |
Europe | |
United Kingdom | |
Corporate | United States |
Europe | |
Mortgages | United States |
Supranational | All the World |
Equity | United States |
Developed excluding United States | |
Emerging Markets | |
Commodities | All the World |
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Diaz, D.E., García-Pulgarín, J.D., Porras, C., Ruíz, M. (2018). Hedging Potential Liabilities of Foreign Reserves Through Asset Allocation. In: Bulusu, N., Coche, J., Reveiz, A., Rivadeneyra, F., Sahakyan, V., Yanou, G. (eds) Advances in the Practice of Public Investment Management. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-90245-6_1
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DOI: https://doi.org/10.1007/978-3-319-90245-6_1
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