The Currency Composition Management Of Foreign Exchange Reverses Based On Factor Analysis: An Empirical Study In China

The foreign exchange reserves of China increase rapidly resently. Up to February 2006, foreign exchange reserves of China have reached 853.6 billion, and China has become the country which holds the most foreign exchange reserve. Thereafter the quantity of reserves was increasing all the time, and reached 1202.031 billion in March 2007. However, such a great amount of reserves will bring risks with it. Meanwhile, changes in numerous complications will challenge the currency composition of our reserves, e.g. the diversity of our tread objects after entering WTO, the regulation of RMB exchange rate system and the adjust of intervention needs in foreign exchange maket. Hence, it becomes one of the most important subject that how to work out the optimal currency composition.This paper is concerned with the issue of finding a suitable currency composition for the foreign exchange reserves. The study of currency allocation in foreign exchange reserves consists of two aspects: kinds of currencies included and their proportions. On one hand, it is rational that our central bank primarily invests in the five major world currencies, namely the US dollar, yen, euro, pound sterling and Swiss franc to adapt the diversified trend of international reserves as well as reduce the management difficulties and costs led by excessive categories of currency. On the other hand, US dollar takes more than 70% in our reserves which means that risks are concentrated upon one currency. Obviously, it is unreasonable. So, according to our status quo, we choose 8 factors which affect the composition of foreign exchange reserve on the base of related theories and reserches. They are as follows: the share of foreign trade, the composition of external debt and foreign investment, the risk and yield of reserve currencies, the exchange rate arrangement, the opportunity cost and international status of currencies. Then the optimal composition of reserves is figured out using factor analysis and can be managed in terms of the conclusion. Finally, we provide suggestions on foreign exchange reserve management comparing the actuality to our empirical study results.