Working Paper: NBER ID: w16392
Authors: Joshua Aizenman; Reuven Glick
Abstract: This paper presents a model comparing the degree of asset class diversification abroad by a central bank and a sovereign wealth fund. We show that if the central bank manages its foreign asset holdings in order to meet balance of payments needs, particularly in reducing the probability of sudden stops in foreign capital inflows, it will place a high weight on holding safer foreign assets. In contrast, if the sovereign wealth fund, acting on behalf of the Treasury, maximizes the expected utility of a representative domestic agent, it will opt for relatively greater holding of more risky foreign assets. We also show how the diversification differences between the strategies of the bank and SWF are affected by the government's delegation of responsibilities and by various parameters of the economy, such as the volatility of equity returns and the total amount of public foreign assets available for management.
Keywords: Asset Class Diversification; Central Banks; Sovereign Wealth Funds
JEL Codes: E58; F15; F30; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Central Bank's objective of minimizing sudden stops in capital inflows (F32) | Higher weight on safer assets (G51) |
| Central Bank's focus on downside risk (E52) | Conservative portfolio strategy (G11) |
| Sovereign Wealth Fund's goal of maximizing expected utility (G23) | Preference for riskier, higher-yielding assets (G11) |
| Central Bank's risk aversion (E58) | Lower equity holdings compared to Sovereign Wealth Fund (G23) |
| Economic factors (e.g., volatility of equity returns) (G19) | Influence on asset management strategies (G11) |