Should Larger Reserve Holdings be More Diversified?

48 Pages Posted: 26 May 2010

See all articles by Roland Beck

Roland Beck

European Central Bank (ECB)

Sebastian Weber

International Monetary Fund (IMF)

Date Written: April 23, 2010

Abstract

The notable increase in international reserve holdings over the past decade and their use during the global financial crisis of 2008/2009 has sparked renewed interest in the analysis of the optimal level of reserve holdings, in particular in countries which are subject to sudden stops. Less attention has been given to the optimal composition of reserves and even less to the joint determination of level and composition. In light of current developments, we show that despite the common belief that higher reserve levels should go along with higher diversification to minimize the opportunity costs from holding reserves, the opposite may even be true. It depends on the factors that stand behind the increase in reserves whether increased diversification is optimal or not. We estimate for a panel of 20 countries the determinants of the currency composition of reserves and show how it is affected by the different motives of reserve accumulation. In line with the recent literature on reserve levels we find that reserve accumulation is primarily driven by precautionary motives, which in turn underpins the allocation of reserves to safe assets. While we find primarily evidence of the allocation being a function of precautionary motives, we also find some weak evidence for reserve accumulation to lead to more diversified portfolios if reserve accumulation is driven by other factors than precautionary motives.

Keywords: Reserve Accumulation, Currency Composition, Precautionary Motives

JEL Classification: F31, F33, E42, G11

Suggested Citation

Beck, Roland and Weber, Sebastian, Should Larger Reserve Holdings be More Diversified? (April 23, 2010). ECB Working Paper No. 1193, Available at SSRN: https://ssrn.com/abstract=1600727

Roland Beck (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Sebastian Weber

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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