Proceedings of Annual Paris Business Research Conference
13 - 14 August 2015, Crowne Plaza Hotel Republique, Paris, France
ISBN: 978-1-922069-82-5
Risk Minimization on Central Bank’s Bond Portfolio with
Multi-Weight Constraint: Bayesian Spanning Test
Timbul Budi Santosoa1, Jonathan Fletcher b and Krishna Paudyalc
This paper investigates whether a typical central bank is made better off by three
spanning strategies (longer bond maturity; emerging government debts; and inflationlinked government bonds) to their existing benchmark portfolio. I measure the reduction
of portfolio risk as the benefits of diversification using Bayesian approach of Wang
(1998) and Li, Sarkar, and Wang (2003) combined with assets weight constraints of
Jagannathan and Ma (2003). I develop a scenario analysis for short-sale constrained
investors. I examined the impact of varying budget constraints, liquidity buffer allocation,
and global financial crisis investment opportunities; and a test for sample selection bias.
Our results shows that it needs inflation-linked bond to be added together with emerging
market and longer dated government bond up to ten years to achieve significant
diversification benefits. Analysis on the impact of budget and liquidity allocation
constraints provide policy implication that central bank should not to tranche their
reserves, but express liquidity requirements in the form of constraints on the portfolio
optimization framework. The impact of global financial crisis emphasizes the need for
central banks to diversify their foreign reserves benchmark beyond its current setting.
Keywords: Bayesian Government bond Risk minimization Multi-weight constraint
Central bank Portfolio optimization
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a
PhD Student, Department of Accounting and Finance, University of Strathclyde, Glasgow G4 0LN, U.K|
Portfolio Manager, Bank Indonesia (Central Bank), Jakarta, Indonesia.
b,c
Professor, Department of Accounting and Finance, University of Strathclyde, Glasgow G4 0LN, U.K
1
Corresponding author: t: +44 141 548 5793 f: 0141 552 3547. E-mail address: timbul-budisantoso@strath.ac.uk timbul_budi@bi.go.id