Abstract
We provide a parsimonious model with two international currencies (dollar and quasi-dollar) to examine the endogenous linkage among trade invoicing, bank funding and optimal currency choices in central banks’ international reserves. We find that (1) when the exchange rate volatility is high, an increase in dollar debt share would lead central banks to hold a larger dollar share in international reserves; (2) when exchange rates of dollar and quasi-dollar move in the same direction, they tend to cut dollar share in reserve holdings. We test these predictions using a newly-available foreign exchange reserve currency composition dataset and find considerable support.
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