The New Conceptual Risk Budget Framework and Implementation of the New FX Reserves Investment Strategy at the Central Bank of Hungary

Abstract

Reserve portfolios prior to the Global Financial Crisis provided positive (low) returns for central banks or had extremely low probabilities of earning negative returns. In the wake of the crisis, expansionary monetary policy created a low yield environment at a scale that was never seen before. Central banks like the Central Bank of Hungary (MNB) had to make a decision: either continue reserve management based on the traditional approach or increase their risk tolerance for higher yields. The Bank decided to embrace a new approach, i.e. put in place a risk budget framework in reserve management. This framework aims to find the optimal strategic asset allocation of the institution based on the risk appetite and capacity of the Bank and to prudently keep the risk of the portfolio within the predefined levels. In practice, the risk budget is a risk measure expressed in nominal terms that cannot be exceeded by the portfolio. This paper presents the implementation process of the MNB’s risk budget framework, including the determination of the risk budget size and the new strategic asset allocation.

Full Publication: Reserve Management and FX Intervention

Keywords: risk budget, risk management, expected shortfall, international reserves, strategic asset allocation, reserve adequacy

JEL Classification: E58, F31, F32, F33, G11