We would like to thank two anonymous referees for their comments on an earlier draft.
Should Larger Reserve Holdings Be More Diversified?†
Article first published online: 23 FEB 2012
© 2012 Blackwell Publishing Ltd.
Volume 14, Issue 3, pages 415–444, Winter 2011
How to Cite
Beck, R. and Weber, S. (2011), Should Larger Reserve Holdings Be More Diversified?. International Finance, 14: 415–444. doi: 10.1111/j.1468-2362.2011.01289.x
- Issue published online: 23 FEB 2012
- Article first published online: 23 FEB 2012
The notable increase in international reserve holdings over the past decade and their use during the global financial crisis has sparked renewed interest in the analysis of the optimal level for reserve holdings. However, less attention has been paid to the optimal composition of reserves and even less to the joint determination of level and composition. We show that despite the common belief that higher reserve levels should lead to greater diversification to minimize the opportunity costs of holding reserves, the opposite appears to be true. Across a sample of 20 countries, we find that reserve accumulation is driven primarily by precautionary motives, underpinning in turn the allocation of reserves to safe assets. More generally, we show that a positive relationship between increases in reserves and reserve diversification should be expected only if the reserve increase is not being driven by precautionary motives.