Copula-VaR Based Currency Composition Analysis In Foreign Exchange Reserve

In recent years,China's foreign exchange reserve scale increased at a remarkable rate,which is more than 2 trillion U.S.dollars now. Such a huge scale makes foreign exchange reserve's value increasing and risk avoiding of a great significance,so the risk management of foreign exchange reserve becomes an important research project. After the collapse of the Bretton Woods System,exchange rate fluctuation became the main source of the risks in foreign exchange reserve.In order to avoid such kind of risks,lots of countries have taken measures to diversify their foreign exchange reserve composition,which means they choose different currency structure to reduce the overall risk.This paper considers our foreign exchange reserve as a portfolio composed of two foreign exchange assets—U.S.dollar and Euro and then estimates the overall portfolio risks when the relative proportion of the two currencies changed. In this process,we measures portfolio risks by calculating it's VaR value and at the same time,we use Copula function to improve the accuracy of VaR calculation,which is a mathematical method and widely used in the field of financial risk analysis.Starting with U.S. dollar and Euro's exchange rate data to RMB,this paper first selected an Archimedean Copula which is the most suitable one to calculate the VaR value of a portfolio composed of two foreign exchange assets,and then we estimated it's parametre.After that, by using Monte Carlo Simulation, we calculated the portfolio's VaR value when the relative proportion of the two currencies changed with the help of Matlab programming. At last we conclude that our foreign exchange reserve's VaR value reduced when the proportion of U.S.dollar increased,whereas the proportion of Euro decreased.So based on the view of risk management, China's foreign exchange reserve should reduce the proportion of Euro and accordingly, increase the proportion of U.S.dollor.Since China's current exchange system is pegging RMB to U.S.dollar rather than full market-oriented, the exchange rate volatility of U.S.dollar to RMB is obviously less than the other currencies, which equals the larger U.S.dollar's proportion,the smaller the portfolio's risks.So this reality has proved the correctness of the front calculation methods and conclutions.In addition,the determination of one country's foreign exchange reserve composition is also affected by factors such as income,global economic environment,a country's trade condition and even some political and diplomatic factors.So it is imcomplete to determine a specific foreign exchange reserve compsition just by the use of Copula-VaR method,we should do some deeper research with a comprehensive consideration of the other factors.