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A parsimonious model of trade, finance and endogenous currency choices in international reserves

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  • Lu, Dong
  • Mu, Yuhao

Abstract

We provide a parsimonious model with two international currencies (dollar and quasi-dollar) to examine the endogenous linkage among trade invoicing, bank funding and optimal currency choices in central banks’ international reserves. We find that (1) when the exchange rate volatility is high, an increase in dollar debt share would lead central banks to hold a larger dollar share in international reserves; (2) when exchange rates of dollar and quasi-dollar move in the same direction, they tend to cut dollar share in reserve holdings. We test these predictions using a newly-available foreign exchange reserve currency composition dataset and find considerable support.

Suggested Citation

  • Lu, Dong & Mu, Yuhao, 2023. "A parsimonious model of trade, finance and endogenous currency choices in international reserves," Economics Letters, Elsevier, vol. 225(C).
    • Handle: RePEc:eee:ecolet:v:225:y:2023:i:c:s0165176523000885
    DOI: 10.1016/j.econlet.2023.111063
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    References listed on IDEAS

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    Cited by:

    1. Mateane, Lebogang, 2023. "Risk preferences, global market conditions and foreign debt: Is there any role for the currency composition of FX reserves?," Research in Economics, Elsevier, vol. 77(3), pages 402-418.

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    More about this item

    Keywords

    Currency choices; International reserves; Foreign debt; Exchange rate volatility; Exchange rate comovement;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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