Portfolio Management of Foreign Exchange Reserves in China

Abstract

In recent years, foreign exchange reserves in China have increased dramatically. However, the financial crisis and European debt crisis aggravated and the portfolio structure of foreign exchange reserves in China is quite unbalanced. Making a balance between safe motivation and profit motivation is worth to be paid attention to. This paper is based on the Merton Model to deal with the optimal portfolio of foreign exchange reserves' investment. I considered four main countries according to the international trade partners and status in financial markets. For each country, I selected four kinds of government bonds which differ in duration. Risky assets in different currency are related to exchange rate variability. I did regression to show the relationship between the optimal weight of government bond and yield, risk and exchange rate variability respectively. It gives implications about adjusting investment weight as the government bonds' yield and risk change from the economic perspective.