China's Foreign Exchange Reserves Portfolio Optimization

Foreign exchange reserves are the financial assets in convertible foreign currency held by a government, and it is an important component of international reserves. By the end of 2010, China's foreign exchange reserve has exceeded 2.8 trillion U.S. dollars, which still remain the first position in the world. After the sub prime mortgage crisis, vast majority of China's foreign exchange reserves which invested in U.S. government bonds are facing serious problem of shrinking at the background of America economic slowdown and RMB appreciation. Therefore, how to maintain and increase the value of reserve assets, how to improve the efficiency of China's foreign exchange reserves? These problems need to be resolved immediately in foreign exchange reserve management. In this paper, instructed by Roy safety first standard and Markowitz model, the author uses out of sample rolling origin prediction method, simulates optimal investment path. This study has shown that foreign exchange reserve diversification can reduce risk and in appropriate conditions can increase revenue.In this paper, the research object is foreign exchange reserves investment portfolio. The study investigates how to maximize the return on investment portfolio on the premise of ensuring security. Firstly, the author analyzed the foreign exchange reserves portfolio optimization's theoretical meaning and factual meaning by the introduction of study's background. This paper systematical reviews the related literature home and abroad from three aspects:foreign exchange reserves moderate scale, foreign exchange reserves portfolio optimization and risk management, and then analyzes the characteristics of foreign exchange reserves portfolio, management principles, investment levels and models of investment management. Chapter Four and Chapter Five are mainly empirical analysis. After analyzing the current situation of China's foreign exchange reserves portfolio, the author estimates return on investment from China foreign exchange reserves. In the estimation we found that the real rate of return is negative. It confers that in order to maintain liquidity, China has paid a high cost.Study found that China's foreign exchange reserve have problems like single asset structure, the high opportunity cost of management, single management system and so on. Then we analyzed these issues in depth. Chapter Five is mainly about the effective combination paths of foreign exchange reserves. Instructed by Markowitz model and Roy safety first standards, by using rolling out of sample prediction method for empirical analysis, it compared different investment routes, at last, concluded the best investment route. It confirms that the diversity of investments on the premise of ensuring safety can achieve maximum benefit.Finally, the article makes policy recommendations of foreign exchange reserves portfolio optimization: China's foreign exchange reserves can be optimized through adjusting the structure and maturity structure of financial assets which can be represented by U.S. dollars, increasing gold reserves, increasing allocation in the amount of non-financial assets, an appropriate increasing overseas equity properly and other means to optimize the combination of purposes.