Foreign exchange reserves management in the presence of jump risk

Abstract

This article investigates how the jump in the exchange rate and risky asset can affect the central bank's foreign management. We find that the jump in the exchange rate has a positive impact on the need for the risky asset, whereas the jump in the risky asset has a negative impact. However, the overall impact relies on how effective the central bank can intervene in the exchange market. Specifically, if the central bank can intervene in the market effectively, the safety of foreign reserves becomes a more important issue, which will decrease the need for risky asset.

Keywords:

• foreign reserves management
• exchange rate
• intervention
• jump risk

JEL Classification:

• E58
• F31

Acknowledgements

This study is supported by the National Science Foundation of China (No. 70831004, 71001071).

Notes

¹ See Coronado (2000) for a detailed list of empirical works that demonstrate the fat-tailed property of financial returns.

² For instance, to push the home currency up, the central bank can sell an amount of foreign currency in the market.