The sovereign property of foreign reserve investment in China: A CVaR approach

This paper investigates the role of foreign exchange reserve investment to hedge overall macroeconomic risks. Different from usual micro profit-maximizing purpose, the investment with macro objective is unique in the field of foreign reserve investment. We propose a framework of mean-variance-CVaR (conditional value at risk) model to capture the features of such investment and calculate the optimal allocation of foreign reserves in China. We use Cornish-Fisher method to calculate CVaR and adopt quasi-Newton algorithm to solve the optimization problem. Two scenarios are compared in the paper: the usual micro profit-maximizing portfolio and the sovereign portfolio hedging macro risks. We find that hedging the overall macro risks and lower the overall volatility of the economy through foreign reserve investment is possible under certain risk constraints.

► We investigate the optimal asset allocation for China's foreign reserve investment. ► We adopt mean-variance-CVaR optimization model. ► We show that it's possible to use reserves to hedge against macroeconomic risks.