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Towards greater diversification in central bank reserves

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This article compares the performance of various diversification strategies regarding foreign exchange reserves. The aim is to provide central banks with guidelines in portfolio allocation. We pay particular attention to the situation of upward pressures on US interest rates by implementing our analysis over both the whole 1986–2015 period and a rising rate subsample. Relying on geometric tests of mean-variance efficiency, we show that introducing currencies weakly correlated to the USD (AUD and CAD) significantly reduces portfolio risk. Expected return is improved through mortgage-backed securities, corporate bonds and equities.

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  1. This is the case for most worldwide central banks, with the notable (and evident) exception of the US Federal Reserve. In this article, we disregard the special situation of the Federal Reserve.

  2. See Currency Composition of Official Foreign Exchange Reserves: Foreign currency diversification is still weak, the claims in the different currencies being as follows at the end of 2014: 22 per cent in euro (EUR), around 4 per cent in British pound (GBP) and Japanese yen (JPY), close to 2 per cent in Canadian dollar (CAD) and Australian dollar (AUD) and 0.3 per cent in Swiss franc (SWI). Around 93 per cent of forex reserves are invested in just four currencies: USD, EUR, JPY and GBP.

  3. Other examples include the Bank of Israel and the Czech National Bank, which have also raised their equity exposures to more than 10 per cent of reserves.

  4. See the so-called ‘exorbitant privilege’ (Eichengreen, 2011; Cova et al, 2015).

  5. The SDR is an interest-bearing international reserve asset created by the IMF in 1969 to supplement other reserve assets of member countries. The SDR is based on a basket of international currencies comprising the US dollar, Japanese yen, euro and pound sterling (

  6. Many central banks are planning to increase their holdings of advanced country currencies, which are not part of the SDR basket (Morahan and Mulder, 2013).

  7. A ‘sudden stop’ is an abrupt reduction in private capital inflows.

  8. According to Ben-Bassat (1980), the composition of developed countries’ reserves is mainly influenced by the stability of the international monetary system, whereas developing countries care mainly about the profitability and liquidity of their reserves.

  9. Some examples are Korea Investment Corporation and China Investment Corporation, respectively, launched in 2005 or 2007.

  10. These shares correspond to the IMF average allocation of central banks in the G4 currencies (data collected in 2014, see footnote 2). These four currencies serve as the reference for the SDR and are now mostly used by central banks to diversify their forex reserves (Morahan and Mulder, 2013).

  11. See These figures are those of June 2015.

  12. Moreover, Medeiros and Nocera (1988) show that the SDR plays a key role in central banks’ reserve allocation.

  13. We consider diversification in the US assets only. The mortgage-backed securities market is much less developed in non-US countries, and the high-yield Japanese market is almost inexistent. Moreover, corporate bond markets and equity markets have a relatively high correlation across the different geographical zones (Brière et al, 2012). US corporate bonds and stock returns may be a good proxy for international returns.

  14. Goldberg et al (2013) describe the strategies of other central banks.

  15. In fact, our sample comprises only two dates with isolated rises in interest rates, namely May 1986 and March 1997. Moreover, Figure A1 in Appendix shows that in times of US rate hikes, non-US central banks tend to increase their rates as well, especially in Canada and in the Eurozone.

  16. It is worth mentioning that this choice is not benign, as numeraires play a key role in asset allocation issues (Borio et al, 2008a, 2008b). Strictly speaking, the numeraire should depend on the use of forex reserves. For example, if the purpose of the reserves is to access imports under stress, then the numeraire could be a basket of imports. By contrast, if the reserves are meant to hedge the country’s debt, the numeraire should be linked to the composition of the debt currency, which typically combines USD and domestic currency. Alternatively, the domestic currency could be used as the numeraire. This would meet central banks’ concerns about the impact of fluctuations in the value of reserves on profitability and capital (Borio et al, 2008a, 2008b; Ramaswamy, 2008). As argued by Ramaswamy (2008, p. 46), ‘the reserves could also be viewed as domestic wealth whose value is to be maximized’.

  17. For more details on the two tests, see Brière et al. (2013).

  18. A slightly lower return (4.62 per cent, see Column (7)) can be achieved without alternative currencies: 58 per cent US short-term government bonds, 11 per cent high-yield corporate bonds, 12 per cent equities, 14 per cent GBP and 4 per cent JPY.


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Correspondence to Marie Brière.

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1holds a PhD in Economics and is Head of Investors Research Center at Amundi, Affiliate Professor of Financial Economics at Paris Dauphine University (France) and Senior Associate Researcher at the Université Libre de Bruxelles, SBS-EM, Centre Emile Bernheim (Belgium). Her research focuses on long-term asset allocation and risk management, with the goal to advise strategic decisions of institutional investors. She is the Managing Editor of the academic journal Bankers Markets and Investors. Her articles have been published in academic journals including the Financial Analyst Journal, Journal of Banking and Finance, Journal of International Money and Finance, Journal of Portfolio Management and so on.

2holds a PhD in Economics and is Professor of Economics at the University of Paris Ouest (France) where she teaches macroeconomics, finance and econometrics. She is also director of EconomiX-CNRS, a research center in economics operated by the CNRS (National Centre for Scientific Research) and the University of Paris Ouest, and scientific advisor to the French center for research and expertise on the world economy (CEPII). Her main research interest concerns international macroeconomics, finance and econometrics. She has published many articles in international peer-reviewed academic journals and various books in macroeconomics, finance and econometrics.

3holds a MSc in Management, a Master in Art History and Archeology, and a PhD in Economics and Management from the Université Libre de Bruxelles. After a postdoctoral stay at Rutgers University (the State University of New Jersey), he became professor at the Université Libre de Bruxelles where he currently teaches finance. His main research interests are sovereign bond valuation, financial history and art market investments. He has published in several academic journals such as American Economic Review (Papers and Proceedings), Journal of Economic History, Journal of Monetary Economics and Review of Finance.



Figure A1

Figure A1
figure 4

Foreign central bank target interest rates during times of rising fed funds rates.

Source: Authors’ calculations based on data extracted from Bloomberg (ECB main refinancing operations announcement rate, Bank of England official bank rate, Bank of Japan unsecured overnight call rate, Bank of Canada overnight lending rate, Reserve Bank of Australia cash rate target).

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Brière, M., Mignon, V., Oosterlinck, K. et al. Towards greater diversification in central bank reserves. J Asset Manag 17, 295–312 (2016).

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