Empirical Research On Foreign Exchange Reserve And Currency Selection In China

After 1997 Asian financial crisis, foreign exchange reserve of China began to increase, especially increasing more quickly from 2001 with an increase of 37%. The low rate of return in foreign exchange reserve is making its opportunity costs quite high. All these show that the present investment structure in China is in a state of unbalance, which is one of the most important factors resulting in unsuitable profits and costs. Starting from the currency structure and investment proportion in Chinese foreign exchange reserve, this paper aims to disclose the problem existed in foreign exchange reserve in China, and also expects to give significative policy implications to decision- makers.Based on the theory of the modest foreign exchange reserve, we pay more attention to the methods of ratio analysis, cost-benefit and econometric model. At the same time the paper makes empirical analysis by using ratio analysis and Frenkel model. We find that the Frenkel model can better explan the fluctuation of Chinese foreign exchange rate, but ratio analysis is absence of explanatory power to do with the problem. On currency selection in view of the global foreign exchange reserve, U.S. dollar, euro, yen and sterling are the most important currencies in the world. And U.S. dollar is about 65%-70% of foreign exchange reserve in China, which is in a quite high proportion. Based on Markowitz mean-varance methond, we can see that: (1) no matter under the framework of fixed exchange rate or floating exchange rate, the mimimized risk increases with the increased expected return; U.S.dollor is not suggested to select in investment; yen is thought as a good investment selection if the lower risk is considered. These results are mainly relative to the higher fluctuation of dollars, the lower fluctuation of yen in return rate and U.S.dollor is recently devaluing relative to Renminbi. (2) if the higher return rate is considered, sterling is a good option under the framework of fixed exchange rate, and euro is another selection under floating exchange rate. At the same time, based on the analysis of minimax value-deviation portfolio selection model, we can also see that: (1) the allocation proportion of dollars is showing the degressive trend with the change of time, and it is almost 40% recently; (2) the proportion of euro is increasing, especially in 2008 it is almost 25%; (3) U.S.dollor and euro are always in a higher proportion among the selected four currencies with the increased expected return from 3% to 5%.In conclusion, by analyzing the modest foreign exchange reserve and currency selection in China, we find that the present theory and models are difficult to explain the state of Chinese foreign reserve. Comparatively speaking, econometric model and minimax value-deviation portfolio selection model are suitable to explain this point. Based these researches above we give some suggestions to improve management of foreign reserve. And also we give some suggestive directions to make management of foreign reserve towards benign development in China.