A Study On The Term Structure Of China’s Foreign Exchange Reserve Investment

In recent years, China’s foreign exchange reserve has maintained rapid growth. China’s official foreign exchange reserve reached3.181trillion U.S. dollars in December,2011. By the end of June,2010, China’s holding of U.S. securities reached1610million U.S. dollars. Among these U.S. securities, long term treasury bonds reached1606million U.S. dollars, took up72%of China’s foreign exchange reserve investment. While corporate bonds investment and equity investment took up only6.9%and0.47%of China’s foreign exchange reserve investment respectively. Under the background of the depreciation of U.S.dollar and the crisis of European sovereign credit rating, huge foreign exchange reserve and unreasonable foreign exchange reserve investment structure will not only brought huge funds outstanding for foreign exchange and the resulting write-off costs, but also faces exchange rate risk, interest rate risk, liquidity risk as well as political risk.Risk management of foreign exchange reserve, especially the optimization of term structure, is basically a brand-new area for China’s foreign exchange reserve investment. Therefore, along with China’s foreign exchange reserve risk management practice, using the theories and methods of bootstrap method, polynomial estimation model, Nelson-Siegel model, Vasicek model, CIR model, DCC-GARCH model and Mean-CVaR model, we studied the term structure of China’s foreign exchange reserve systematically, providing strong support for decision-making on China’s foreign exchange reserve investment.In this dissertation, a systematic and intensive study is made on the term structure of China’s foreign exchange reserve investment, including estimation of foreign exchange reserve’s term structure, optimization of the term structure and adjustment strategy. It mainly consists of five parts:The first part is preliminary analysis of the term structure of China’s foreign exchange reserve. We review the literature of foreign exchange reserve investment and interest rate term structure; analyze the current status of China’s foreign exchange reserve investment, including its scale, its currency structure as well as its term structure. We also point out the potential risks that China’s foreign exchange reserve would face. We summarizes the interest determination theories and the macro economic factors that would have an impact on the term structure, such as monetary policy, fiscal policy, economic cycle, inflation and resident income and so on.The second part studies the theoretical basis of model designing. Firstly, we introduce the static interest rates term structure models, such as interpolation models and fitted models as well as their characters respectively. Secondly, we introduce the dynamic generalized equilibrium models of interest rates term structure, such as Merton model, Vasicek model, CIR model and multifactor equilibrium models.The third part makes a static empirical study and a dynamic empirical study on the term structure of China’s foreign exchange reserve investment respectively. We choose the Treasury bond sample data of USA, Japan, Britain and Germany, by utilizing Nelson-Siegel model, we make a static empirical study on the term structure of the assets, and then we achieve each country’s T-bond term structure. Based on CIR model, we make a dynamic empirical study on the term structure of China’s foreign exchange reserve. By analyzing the shape of the curves as well as their movement, we draw a conclusion of how to adjust the term structure of China’s foreign exchange reserve.The fourth part studies the allocation of the term structure of China’s foreign exchange reserve investment, including design the theoretical model, correlation analysis by DCC-GARCH model, empirical study by mean-CVaR Model and so on. The model takes an overall consideration of security, liquidity and profitability. We assume that China’s foreign exchange reserve consists only of long term T-bonds and short term T-bonds. We analyze the impact of interests variation will have on the allocation of the two assets. Choosing the T-bond sample data of USA, Japan, Britain and Germany, we utilize DCC-GARCH model to test the interdependency among long term, mid-term and short term T-bonds of each country. By using mean-CVaR model and asset portfolio theory, we get the ideal term structure allocation of China’s foreign exchange reserve investment.The fifth part draws a conclusion. Based on the previous analysis and the results of empirical tests, this part brings forward the adjustment strategy as well as policy proposal for the management of the term structure of China’ s foreign exchange reserve investment.