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Coche, Joachim
Koivu, Matti
Nyholm, Ken
Poikonen, Vesa
Year of Publication: 
Series/Report no.: 
ECB Working Paper 624
This paper studies the implications of introducing an explicit policy objective to the management of foreign reserves at a central bank. A dynamic model is developed which links together reserves management and the exchange rate by foreign exchange interventions. The exchange rate is modelled as a mean-reverting autoregressive process incorporating a linear response to interventions. The premise is that it is the objective of the central bank to prevent undervaluation of its currency. Given this objective, the model is formulated in a one- and a multi-period setting and solved to find the optimal asset allocation. The results show that asset allocation can significantly help in achieving the desired policy objective.
exchange rate modelling
foreign exchange intervention
Foreign reserves management
optimal asset allocation
Document Type: 
Working Paper

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