International Reserves Management and Currency Allocation: A New Optimisation Framework Based on a Measure of Relative Numeraire Risk (RNR)

Abstract

This paper addresses the challenges involved in optimising the currency allocation of international reserves portfolios based on ex ante risk-return statistics measured in one numeraire (e.g. chosen to reflect the economy’s import currency composition), while reserves size continues to be scrutinised ex post in another numeraire (i.e. USD). This paper proposes the Relative Numeraire Risk (RNR) measure to capture quantitatively (basis points) how Pareto-suboptimal efficient frontier in one optimisation numeraire will appear in different report numeraire(s) and outlines the RNR reserves management framework. Experiments entailed 6 numeraire choices on weekly (2000 to H1-2009) FX/government bond data in 4 reserves currencies.

Keywords: Reserves Management, Currency-Asset Allocation, Numeraire Definition, Pareto Inefficiency