The Structural Risk Analysis Of China’s Foreign Exchange Reserves Based On Entropy Model

Since the beginning of twenty-first century, thanking for situations like trade structure, the exchange rate pegs, and the foreign investment flowing into China, our foreign exchange reserves are extremely growing fast. The aggregate number got to 3800 trillion in 2007, developing into the first in the world. This is equivalent to some middle-income countries annual GDPs. China’s government accumulated a large reserve assets by holding assets dominated in foreign currency, which once exercised to duties as maintain the independence of monetary policy, international trade settlement paying approach and so on. But the good point of reserves as asset is getting vanished with the increasing scale, becoming nation’s burden or even a time bomb, is raising risk.This article brings up a consideration of how to measure the risk of foreign reserves as they are quickly expanding. At the first, I have an international comparison. There are a big number of samples to study the currency structure of China’s foreign reserve with the method of practical evidence. Although the State Administration of Foreign Exchange didn’t explicitly announce currency structure and invest objection of foreign exchange assets, there are also a lot of international organizations and foreign apartments published a lot of statics about holdings of reserves. The article circumstantially speculated the foreign reserve holding structure.After the study of the holding structure, we could begin to research the risk of foreign reserves according to it. This paper summarizes the risk of foreign exchange reserves from two aspects of external and internal risk. The external risk, also called scale risk, meaning that the adverse effect which the excess reserve assets gave to national economy. Including the inflation risk that products and resources flowing outside the country. The internal risk also called the structural risk. This part points to possibility of the devaluation of foreign reserve holdings with the reasons such as disequilibrium of currency structure, bad decision of investment. Including the fluctuation of exchange rate and interest rate that leading to the risk of foreign assets’valuation, and the possibility of default of foreign debt. In summary, there are two parts of risk for holding too much reserve assets. One for the asset’s externalities and one for its devaluation.At last, the paper quantitatively analysis the structural risk of foreign reserves. I see the reserve asset as a portfolio of financial asset which is composed of several kinds of currencies. In that way the risk of foreign reserves is also the risk of the portfolio. On basis of summarizing several typical approaches for quantitative risk assessment and comparing them by advantages and disadvantages, this paper picked one method for quantitative risk assessment. The article also made some suggestions for optimizing currency structure. The study of this paper have both theoretical and practical significance. There are also some innovation and breakthrough for foreign reserve asset structural research.