Accumulation of Large Foreign Reserves in China: A Behavioural Perspective

Economic Change and Restructuring, 2013: 46(1), 85-108

48 Pages Posted: 6 Oct 2011 Last revised: 19 Mar 2013

See all articles by Zhichao Zhang

Zhichao Zhang

Durham University - Durham Business School

Frankie Chau

Durham University Business School

Li Xie

Date Written: December 13, 2012

Abstract

The massive accumulation of foreign reserves by China has challenged the conventional thinking about prudent reserve management. This paper develops a behavioural model of optimal decision making under uncertainty to explain the observed Chinese reserve policy. Departing from the conventional approach to utility maximisation based on the agent’s rationality, this paper explicitly models the behaviour of Chinese central banker who is influenced by loss aversion and narrow framing. Embedding the cognitive biases into the precautionary savings approach to holding reserves, the paper shows the behavioural optimality of Chinese reserve build-up and provides a plausible explanation of the dynamics of reserve accumulation in China, hence help make sense of the puzzling Chinese reserve policy.

Keywords: Reserve accumulation, Precautionary savings, Behavioural finance, Loss aversion, Narrow framing

JEL Classification: C61, F31, F43, G02

Suggested Citation

Zhang, Zhichao and Chau, Frankie and Xie, Li, Accumulation of Large Foreign Reserves in China: A Behavioural Perspective (December 13, 2012). Economic Change and Restructuring, 2013: 46(1), 85-108. Available at SSRN: https://ssrn.com/abstract=1939768

Zhichao Zhang

Durham University - Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

Frankie Chau

Durham University Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

No contact information is available for Li Xie

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