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

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.