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Strategic Asset Allocation for Central Bank’s Management of Foreign Reserves: A new approach

Zhang, Zhichao and Chau, Frankie and Xie, Li (2012): Strategic Asset Allocation for Central Bank’s Management of Foreign Reserves: A new approach.

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Abstract

This paper proposes a new approach to strategic asset allocation for central banks’ management of foreign reserves. This eclectic approach combines the behavioural portfolio management in the framework of mean-variance mental accounting (MVMA) with the improvements on asset return forecast offered by the Black-Litterman (B-L) model, proving particularly suitable for the reserve management policy with multiple objectives. The B-L model is embedded into the MVMA framework to obtain both the equilibrium and the B-L returns as our improved forecasts, formulating forward-looking investment strategies. The approach is applied to the case of China to derive optimal asset allocation for the Chinese central bank.

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