Optimal Reserve Composition In The Presence Of Sudden Stops: The Euro And The Dollar As Safe Haven Currencies
The authors analytically derive optimal central bank portfolios in a minimum variance framework with two assets and "Transaction demands" caused by sudden stops in capital inflows. In this model, the transaction demands become less important relative to traditional portfolio objectives as debt to reserve ratios decrease. They empirically estimate optimal dollar and euro shares for 24 emerging market countries and find that optimal reserve portfolios are dominated by anchor currencies and, at current debt to reserve ratios, introducing transactions demand has a relatively modest effect. They also find that euro and dollar bonds act as "Safe haven currencies" during sudden stops.