Study On Optimal Allocation Of China’s Foreign Exchange Reserves After The U.S. Subprime Mortgage Crisis

Foreign Exchange Reserves is an important indicator to measure a country’s comprehensive national strength. It has many important functions, such as adjusting the balance of payments, keeping the stability of exchange rate, maintaining the international credibility of the currency, and dealing with the uncertainty of international capital flows. The dollar declined because of the U.S. subprime mortgage crisis in2007.China’s foreign currency reserve assets have been expanding and too much focus on the currency structure of the U.S. dollar’s decline continued under a vast reservoir of exchange rate risk..At first, this dissertation studies the currency composition of China’s foreign exchange reserves and assets structure of the U.S. dollar’s, and then the structure problems of China’s foreign exchange reserves. Finally, we get some useful suggestions from the basic conclusions and the management experience of the international foreign exchange reserves.Currency structure of China’s foreign exchange reserves is mainly dominated by the dollars. The single currency structure not only increases the risk of exchange rate, and is not conducive to implement the functions of foreign exchange reserves successfully. This dissertation come out with the optimal proportion of currency structure of China’s foreign exchange reserves by the empirical analysis, which use the Portfolio Selection Theory, Heller-Knight Model and Dooley Model, combining constrains of the balance of risk and benefit, composition of international trade, external debt, foreign direct investment and the economic strength. To be specific, China should be appropriate to reduce the U.S. dollar assets in the foreign exchange reserves, and increase the other reserve currency. Also, we should gradually realize the diversification of China’s foreign exchange reserve currency structure.Because of absolute position of U.S. dollar in the foreign exchange reserves, efficiency in managing dollar assets would directly affect the overall effectiveness of foreign exchange reserve management. Under the M-V theory framework, the dissertation adopts time series of dollars short-term debt, medium debt, long-term government bonds, mortgage bonds, stock returns and the AAA-rated corporate bond from2003to2010to analysis the reasonableness of asset allocation structure. Empirical study concludes that our country should increase investment in AAA-rated corporate bonds to increase the portfolio returns and diversify risk, with the premise of ensuring the liquidity and safety. In addition, the equity investment is another adjustment content of China’s dollar reserve assets.Finally, from the policy recommendations, we should adjust China’s foreign exchange reserve structure gradually:Reducing the U.S. dollar assets in China’s foreign exchange reserves and making the investment structure of it more reasonably. Moreover, we should perfect the foreign exchange reserves management system and the risk management by using experience of other countries for reference.