Currency Movements Drive Reserve Composition
14 Pages Posted: 11 Dec 2014
Date Written: December 2014
A long-standing puzzle in international finance is the durability of the dollar's share of foreign exchange reserves - which remains above 60%, while the weight of the US economy in global output has fallen to less than a quarter. We argue that the dollar's role may reflect instead the share of global output produced in countries with relatively stable dollar exchange rates - the "dollar zone". If a currency varies less against the dollar than against other major currencies, then a reserve portfolio with a substantial dollar share poses less risk when returns are measured in domestic currency. Time series and cross-sectional evidence supports the link between currency movements and the currency composition of reserves.
JEL Classification: E58, F31, F33
Suggested Citation: Suggested Citation