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Risk preferences, global market conditions and foreign debt: Is there any role for the currency composition of FX reserves?

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  • Mateane, Lebogang

Abstract

I estimate a transition probability matrix associated with a two-state Markov process of emerging market economies (EMEs) volatility. The different states of EMEs volatility, generate switches in central bank preferences between approximated constant relative risk aversion and increasing relative risk aversion expected utility. Therefore, I construct and propose constrained portfolio selection frameworks with skewness, for the currency composition of FX reserves over different EMEs volatility states for Brazil, Indonesia and South Africa. These EMEs have constituted as part of the “Fragile Five”. Thus, I propose progressive risk management procedures for these EMEs. These portfolio selection frameworks satisfy Pratt–Arrow measures of risk aversion and are constrained by each country’s currency composition of foreign debt. Using different methods of computing expected FX reserves returns, traditional strategic FX reserve assets and different maturity structures, I simulate optimal FX reserve weights for each EME and validate my proposal.

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  • 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.
    • Handle: RePEc:eee:reecon:v:77:y:2023:i:3:p:402-418
    DOI: 10.1016/j.rie.2023.06.007
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    More about this item

    Keywords

    Expected utility; Portfolio selection with skewness; EMEs currency composition of FX reserves; Foreign debt;
    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
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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