Optimal currency shares in international reserves: the impact of the euro and the prospects for the dollar

Foreign exchange reserve accumulation has risen dramatically in recent years. The introduction of the euro, greater liquidity in other major currencies, and the rising current account deficits and external debt of the United States have increased the pressure on central banks to diversify away from the US dollar. A major portfolio shift would significantly affect exchange rates and the status of the dollar as the dominant international currency. We develop a dynamic mean-variance optimization framework with portfolio rebalancing costs to estimate optimal portfolio weights among the main international currencies. Making various assumptions on expected currency returns and the variance-covariance structure, we assess how the euro has changed this allocation. We then perform simulations for the optimal currency allocations of four large emerging market countries (Brazil, Russia, India and China), adding constraints that reflect a central bank’s desire to hold a sizable portion of its portfolio in the currencies of its peg, its foreign debt and its international trade. Our main results are: (i) The optimizer can match the large share of the US dollar in reserves, when the dollar is the reference (risk-free) currency. (ii) The optimum portfolios show a much lower weight for the euro than is observed. This suggests that the euro may already enjoy an enhanced role as an international reserve currency ("punching above its weight"). (iii) Growth in issuance of euro-denominated securities, a rise in euro zone trade with key emerging markets, and increased use of the euro as a currency peg, would all work towards raising the optimal euro shares, with the last factor being quantitatively the most important. JEL Classification: F02, F30, G11, G15Currency optimizer, euro, Foreign reserves, international currencies

Every crypto breath in the world : the current global position of the cryptocurrency market and future prediction

This study was motivated by the breakthrough of cryptocurrencies in 2018. The other main reasons behind the motivation are the total market capitalisation of one trillion-dollar diversification possibilities and the lack of preceding scientific research to identify the portfolio diversification possibilities of cryptocurrencies from many angles. Four empirical studies were conducted to provide a holistic view of cryptocurrency as an investment tool. The first study investigated the portfolio diversification possibilities between cryptocurrencies and traditional financial markets. A quantitative method was employed with Cointegration, ARDL bound testing approach, causality, and co-movement testing. Applying Modern portfolio theory to identify the diversification possibilities between the aforementioned markets enabled the study to highlight how investors can reap the benefits of cryptocurrencies. The second study extended the investigation of the portfolio diversification possibilities of cryptocurrency by including precious metals and cryptocurrencies in the same investment basket. Investors switch from traditional investment assets, such as equity and debt market instruments, to precious metal markets to reap benefits. Therefore, this study investigates how cryptocurrency can be an alternative source of investment to include in an investment portfolio. The daily precious metal and cryptocurrency data from 2017 to 2022 was utilised through an ARDL framework to obtain the Cointegration between cryptocurrency, precious metal and across cryptocurrencies. Modern portfolio theory is used to identify the diversification possibilities in this study with different portfolio diversification strategies. The third study clarified the cryptocurrency stakeholders to identify the global perception of cryptocurrency investments. A qualitative method was employed with sentiment analysis, followed by data extractions from the global databases using machine learning algorithms. The study identified the percentage of stakeholder groups' positive, negative, and neutral perceptions of cryptocurrency. The main obstacles hindering cryptocurrency investment growth are the fear of current scams, lack of definitional issues and the absence of a legal framework in some countries. The fourth study included the findings from the first, second and third studies to develop a cryptocurrency predictive model by factoring in macroeconomic variables. Panel data regression with fixed and dynamic effects was employed to analyse the data from 2017 to 2002. The findings suggest the impact of each macroeconomic variable selected in the study for the cryptocurrency price changes while adding more significance to technological variables. The overall findings provide strong support for the portfolio diversification possibilities of cryptocurrencies. Inclusions of the wide range of investment classes, exploring stakeholder perception and highlighting the macroeconomic variables' influence on the cryptocurrency price prediction generate new insights and valuable comparisons about cryptocurrency markets for academia, crypto issuers, investors, government, policymakers, and fund managers to use as an investment and decision-support tools. Keywords: Cryptocurrency, ARDL, Financial Markets, Cointegration, Causality, Portfolio diversification, Precious Metals, Predictive model.Doctor of Philosoph

Can gold be used as a hedge against the risks of Sharia-compliant securities? Application for Islamic portfolio management

In this paper, we investigate whether gold hedges Sharia-compliant stocks and Sukuk during the period from September 2005 to October 2017. The inference is taken by using both the DCC-GARCH model and the wavelet coherence analysis. On the whole, our finding suggests that gold is not effective in hedging the fluctuations of Sharia-compliant securities. However, we find that combining gold with stocks (and Sukuk) is useful in diversification and portfolio optimization. These results imply that, while gold is an excellent hedge for plain vanilla securities, it is not for Islamic exposures. This is important in light of the increasing amount of assets that are managed according to Islamic screening

Optimal Currency Shares in International Reserves: The Impact of the Euro and the Prospects for the Dollar

Foreign exchange reserve accumulation has risen dramatically in recent years. The introduction of the euro, greater liquidity in other major currencies, and the rising current account deficits and external debt of the United States have increased the pressure on central banks to diversify away from the US dollar. A major portfolio shift would significantly affect exchange rates and the status of the dollar as the dominant international currency. We develop a dynamic mean-variance optimization framework with portfolio rebalancing costs to estimate optimal portfolio weights among the main international currencies. Making various assumptions on expected currency returns and the variance-covariance structure, we assess how the euro has changed this allocation. We then perform simulations for the optimal currency allocations of four large emerging market countries (Brazil, Russia, India and China), adding constraints that reflect a central bank%u2019s desire to hold a sizable portion of its portfolio in the currencies of its peg, its foreign debt and its international trade. Our main results are: (i) The optimizer can match the large share of the US dollar in reserves, when the dollar is the reference (risk-free) currency. (ii) The optimum portfolios show a much lower weight for the euro than is observed. This suggests that the euro may already enjoy an enhanced role as an international reserve currency ("punching above its weight"). (iii) Growth in issuance of euro-denominated securities, a rise in euro zone trade with key emerging markets, and increased use of the euro as a currency peg, would all work towards raising the optimal euro shares, with the last factor being quantitatively the most important.

Estimating the Currency Composition of Foreign Exchange Reserves

Central banks manage about \$12 trillion in foreign exchange reserves, influencing global exchange rates and asset prices. However, some of the largest holders of reserves report minimal information about their currency composition, hindering empirical analysis. I describe a Hidden Markov Model to estimate the composition of a central bank's reserves by relating the fluctuation in the portfolio's valuation to the exchange rates of major reserve currencies. I apply the model to China and Singapore, two countries that collectively hold about \$3.4 trillion in reserves and conceal their composition. I find that both China's reserve composition likely resembles the global average, while Singapore probably holds fewer US dollars

Does Gold and FPI Influence USD/INR Exchange Rates? Evidence from Autoregressive Distributed Lag Approach

Exchange rates have a major impact on a country’s trade in not only ascertaining the prices but also deciding upon the hedgingrequirements in order to mitigate the risks associated with its fluctuations. These rates have key implications on the way a country’s economy grows and performs.Thepresent study examinesthe impact of important macro-economic indicators (Gold prices and Foreign Portfolio Investments (FPI)) on the exchange rates in the long run and short run. The monthly data was collected from 2003 to 2019. The study employed Auto Regressive Distributed Lag Model (ARDL), a Bounds test to find the long-run and short-run association among the macro-economic variables and the exchange rate. The results show that there exists a short-run and long-run relationship betweenthe USD/INR exchange rate and the macro-economic indicators, Gold and FPI

Optimal reserve composition in the presence of sudden stops: the euro and the dollar as safe haven currencies

We 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. We 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. We also find that euro and dollar bonds act as "safe haven currencies" during sudden stops. Dollars are better hedges for global sudden stops and for regional sudden stops in Asia and Latin America, while the euro is a better hedge for sudden stops in Emerging Europe. We reproduce qualitatively the recent decline in the share of the dollar in emerging market reserves and find that the denomination of foreign currency debt has very little importance for optimal reserve portfolios. JEL Classification: F31, F32, F33, G11currency composition, foreign exchange reserves, sudden stops

Studies on African equity markets and global shocks : co-movement, contagion, and diversification

A Doctoral thesis submitted in fulfilment of the requirements for the award of Doctor of Philosophy degree in the field of Finance The Graduate school of Business Administration, University of the Witwatersrand, October 2016The global financial system has experienced turmoil in the past three decades, at the least. Although the shocks originate abroad, they possess some rippling effects on African economies. The essence of market integration and cross-border listings of stocks has fueled the need for African markets to be well integrated with the global economy. Despite this need, available empirical literature exploring the integration of African markets regionally, and with the rest of the world appear unclear. Moreover, the possibility of global shocks transmitting to Africa via its emerging equity markets remains underexplored. At the same time, such knowledge is critical for not only understanding the functioning of equity markets in particular, but also important for regulating the financial system in general. This thesis addresses these gaps inherent in extant literature and proffer empirical and theoretical solutions by exploring the nexus between African stock markets and global shocks. The emphasis is on contagion, co-movement, and diversification. The thesis is organized into four empirical essays, each deeply touching on specific theme (s) that form the core of the problems or research questions under investigation while employing advanced econometric techniques that underpin the modeling of asset returns. The first essay examines the capacity of African equity markets to act as ‗hubs‘ for portfolio investors during tranquil and turbulent conditions of global equity and commodity markets. The findings posit that African stock markets provide decorrelation from commodity and global equity markets during extreme market conditions. To the extent that the results reveal the strength of African stocks in cushioning international portfolio investors in a mean-variance stand-point during market crashes, the essay helps to decay doubts in the minds of investors on the perceived lack of capacity of the continent‘s stocks to yield higher expected risk-return trade-offs during global market sell-offs. The implication of the study is that given the recent history of commodities and global stocks, fund managers around the world seeking viable alternatives to compensate for losses from commodity shocks through uncorrelated markets may consider the equity markets in Africa, albeit on account of volatility persistence, present and past market conditions, markets stability, as well as size and liquidity issues. The second essay examines regional and global co-movement of African stock markets using the three-dimensional continuous Morlet wavelet transform methodology. The essay establishes evidence of stronger co-movements broadly narrowed to short-run fluctuations. The co-movements are time-varying and commonly non-homogeneous – with phase difference arrow vectors implying lead-lag African Equity Markets and Global Shocks 2016 © Gideon Boako Page iii relationships. The presence of lead-lag effects and stronger co-movements at short-run fluctuations may induce arbitrage and diversification opportunities to both local and international investors with long-term investment horizons. The findings also reveal that some African equity markets are, to a degree, segmented from volatilities of the dollar and euro exchange rates. The third essay sheds light on whether African equity markets decoupled from, and / or converged with regional and global markets from 2003 to 2014, and analyzes the implications of that for shocks spillovers. Although there is no evidence of African markets convergence either regionally or globally, shock propagation exists in a time-varying setting. Regional markets in Africa are not just ‗shock absorbers‘ but also ‗shock transmitters‘. In the last essay, the dependence structure and (extreme) downside developed equity markets and currency price risk spillover effects to African stock markets using value-at-risk (VaR) and conditional value-at-risk (CoVaR) based on stochastic copulas is modeled. The study finds evidence of non-homogenous weak negative dependence between stocks and the USD and EUR exchange rates. Except for Egypt, there is evidence of positive significant dependencies between all African markets and their developed counterparts. Although, evidence of both uni-directional and bidirectional causality, as well as upper and lower tail dependencies are found across the stocks and currency markets, only some minuscule evidence of downside spillover effects was recorded, albeit episodic. It is observed that propagation of shocks from the GFC had a second round effect in African stock markets. Thus, the impact of the GFC to African economies was not through the credit crunches and liquidity freezes in Phase I of the crisis, but rather through the global recession that followed into the second phase. The findings are consistent with the view that global shocks propagation to developing markets may stagger during crisis and intensify post-crisis. A practical implication from the results is that given the relatively scarce resources and levels of technological know-how available to African governments, efforts to wean the continent‟s equity markets from adverse effects of global market crashes should be geared towards plans and programmes to mitigate the shocks not at the early stages but latter stages, where the effects to Africa could be prominently felt. Three key arguments are deduced from all the essays. First, although financial market underdevelopment seems prima-facie, to help countries isolate themselves against immediate contagion, it also reduces the ability of the real economy to cushion the impact of the crisis. African Equity Markets and Global Shocks 2016 © Gideon Boako Page iv Therefore, the argument of the thesis is that despite the common fear that a highly integrated and developed market may present fertile grounds for shock spillover, Africa must continue to pursue programmes aimed at enhancing inter and intra-regional integration. However, the degree and extent of both inter- and intra-regional integration ought to be pegged at certain optimal levels in order to reap benefits from scale economies. Such endeavours at integration will not only help in risk diversification but also help smooth the impact of shocks. The second argument is that, the proposition of the ―decoupling theory‖ i.e. returns of African equity markets and global stocks are not jointly normal during crisis periods may not be entirely tenable, empirically. Thirdly, the thesis argues that the “shift-contagion” theory may not reflect the reality for Africa, particularly during initial stages of crisis. Instead, the thesis suggests an extension and argues for a “delayed-shift contagion” theory. Keywords: Decoupling, shift-contagion, spillover effects, CoVaR, exchange rates, commodities. JEL Classification: C40, C58, F31, F36, G10, G11, G15,GR201